[Senate Report 111-176]
[From the U.S. Government Publishing Office]
Calendar No. 349
111th Congress Report
SENATE
2d Session 111-176
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THE RESTORING AMERICAN FINANCIAL STABILITY ACT OF 2010
_______
April 30, 2010.--Ordered to be printed
_______
Mr. Dodd, from the Committee on Banking, Housing, and Urban Affairs,
submitted the following
R E P O R T
together with
MINORITY VIEWS
[To accompany S. 3217]
The Committee on Banking, Housing, and Urban Affairs,
having considered the original bill (S. 3217) to promote the
financial stability of the United States by improving
accountability and transparency in the financial system, to end
``too big to fail'', to protect the American taxpayer by ending
bailouts, to protect consumers from abusive financial services
practices, and for other purposes, having considered the same,
reports favorably thereon without amendment and recommends that
the bill do pass.
CONTENTS
I. Introduction.....................................................2
II. Purpose and Scope of the Legislation.............................2
III. Background and Need for Legislation.............................39
IV. History of the Legislation......................................44
V. Section-by-Section Analysis of Bill.............................46
VI. Hearing Record.................................................186
VII. Committee Consideration........................................203
VIII.Congressional Budget Office Cost Estimate......................203
IX. Regulatory Impact Statement....................................227
X. Changes In Existing Law (Cordon Rule)..........................230
XI. Minority Views.................................................231
I. INTRODUCTION
On March 22, 2010, the Senate Committee on Banking,
Housing, and Urban Affairs marked up and ordered to be reported
the ``Restoring American Financial Stability Act of 2010
(RAFSA).'' RAFSA is a direct and comprehensive response to the
financial crisis that nearly crippled the U.S. economy
beginning in 2008. The primary purpose of RAFSA is to promote
the financial stability of the United States. It seeks to
achieve that goal through multiple measures designed to improve
accountability, resiliency, and transparency in the financial
system by: establishing an early warning system to detect and
address emerging threats to financial stability and the
economy, enhancing consumer and investor protections,
strengthening the supervision of large complex financial
organizations and providing a mechanism to liquidate such
companies should they fail without any losses to the taxpayer,
and regulating the massive over-the-counter derivatives market.
II. PURPOSE AND SCOPE OF THE LEGISLATION
FINANCIAL STABILITY
Title I establishes a new framework to prevent a recurrence
or mitigate the impact of financial crises that could cripple
financial markets and damage the economy. A new Financial
Stability Oversight Council (Council) chaired by the Treasury
Secretary and comprised of key regulators would monitor
emerging risks to U.S. financial stability, recommend
heightened prudential standards for large, interconnected
financial companies, and require nonbank financial companies to
be supervised by the Federal Reserve if their failure would
pose a risk to U.S. financial stability.
The Federal Reserve would establish and implement the
heightened prudential standards and would have additional
authority to require (with Council approval) a large financial
company to restrict or divest activities that present grave
threats to U.S. financial stability. With respect to bank
holding companies, the heightened prudential standards would
increase in stringency gradually as appropriate in relation to
the company's size, leverage, and other measures of risk for
those that have assets of $50 billion or more. This graduated
approach to the application of the heightened prudential
standards is intended to avoid identification of any bank
holding company as systemically significant. These heightened
prudential standards would also apply to the nonbank financial
companies supervised by the Federal Reserve.
A new Office of Financial Research within the Treasury
Department would support the Council's work through financial
data collection, research, and analysis.
When Treasury Secretary Timothy Geithner presented the
Administration's financial reform proposal at a Committee
hearing on June 18, 2009, he highlighted several shortcomings
of the current supervisory framework that left the government
ill-equipped to handle the recent financial crisis: overall
capital and liquidity standards were too low; regulatory
requirements failed to account for the harm that could be
inflicted on the financial system and economy by the failure of
large, interconnected and highly leveraged financial
institutions; and investment banks and other types of nonbank
financial firms operated with inadequate government
oversight.\1\ FDIC Chairman Sheila Bair testified on July 23,
2009 that the ``existence of one regulatory scheme for insured
institutions and a much less effective regulatory scheme for
non-bank entities created the conditions for arbitrage that
permitted the development of risk and harmful products and
services outside regulated entities. . . . The performance of
the regulatory system in the current crisis underscores the
weakness of monitoring systemic risk through the lens of
individual financial institutions and argues for the needs to
assess emerging risks using a system-wide perspective.''\2\
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\1\Testimony of Timothy Geithner, Secretary of the Treasury, to the
Banking Committee, June 18, 2009.
\2\Testimony of Sheila Bair, Chairman of the Federal Deposit
Insurance Corporation to the Banking Committee, July 23, 2009.
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These and other witnesses at Committee hearings relating to
the financial crisis and financial reform have made the case
for the type of framework established in this title to promote
U.S. financial stability. Treasury Secretary Geithner called
for the creation of a council of regulators chaired by the
Secretary to identify emerging risks in financial institutions
and markets, determine where gaps in supervision exist, and
facilitate coordination of policy and resolution of disputes.
He argued for new authority for the Federal Reserve to set
stricter prudential standards for large, interconnected
financial firms that could threaten financial stability,
including financial firms that do not own banks.\3\ Federal
Reserve Chairman Ben Bernanke called for a new prudential
approach focusing on the stability of the financial system as a
whole, with formal mechanisms to identify and deal with
emerging systemic risks, and for more stringent capital and
liquidity standards for large and complex financial firms.\4\
FDIC Chairman Sheila Bair recommended establishing an
interagency council that would bring a macro-prudential
perspective to regulation and set or harmonize prudential
standards for financial firms to mitigate systemic risk.\5\ At
the July hearing, SEC Chairman Mary Schapiro also testified in
favor of establishing such a council with similar membership
and authorities.\6\ Federal Reserve Board Governor Daniel
Tarullo testified at the same hearing that there was
substantial merit in establishing a council of regulators to
conduct macroprudential oversight and coordinate oversight of
the financial system as a whole.\7\ Former Comptroller of the
Currency Eugene Ludwig argued at a September hearing that no
single regulatory agency would be well suited to handle this
function alone.\8\
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\3\Testimony of Timothy Geithner, Secretary of the Treasury, to the
Banking Committee, June 18, 2009.
\4\Testimony of Ben Bernanke, Federal Reserve Board Chairman, to
the Banking Committee, July 22, 2009.
\5\Testimonies of Sheila Bair, Chairman of the Federal Deposit
Insurance Corporation, to the Banking Committee, May 6 and July 23,
2009.
\6\Testimony of Mary Schapiro, Chairman of the Securities and
Exchange Commission, to the Banking Committee, July 23, 2009.
\7\Testimony of Daniel Tarullo, Federal Reserve Board Governor, to
the Banking Committee, July 23, 2009.
\8\Testimony of Eugene Ludwig, former Comptroller of the Currency,
to the Banking Committee, September 29, 2009.
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At a February 12, 2010 hearing, several witnesses spoke in
favor of the creation of an independent National Institute of
Finance (Institute). While the Office of Financial Research
(Office) would be established in the Treasury Department under
this title, the Office is very similar in key respects to the
proposed Institute. Like the Institute, the Office would
support the council of regulators charged with monitoring
emerging risks to financial stability. The Office would not
supervise financial institutions but would have regulatory
authority with respect to data collection. The Office's
structure is modeled on the proposed Institute, with two main
components to fulfill its primary functions--the Data Center
and Research and Analysis Center. The structure and funding of
the Office are intended to ensure that the Office, like the
Institute, would have the resources and ability to provide
objective, unbiased assessments of the risks facing the
financial system.
ENDING ``TOO BIG TO FAIL'' BAILOUTS THROUGH THE ORDERLY LIQUIDATION
AUTHORITY
Title II establishes an orderly liquidation authority to
give the U.S. government a viable alternative to the
undesirable choice it faced during the financial crisis between
bankruptcy of a large, complex financial company that would
disrupt markets and damage the economy, and bailout of such
financial company that would expose taxpayers to losses and
undermine market discipline. The new orderly liquidation
authority would allow the FDIC, which has extensive experience
as receiver for failed banking institutions, including large
institutions, to safely unwind a failing nonbank financial
company or bank holding company, an option that was not
available during the financial crisis. Once a failing financial
company is placed under this authority, liquidation is the only
option; the failing financial company may not be kept open or
rehabilitated. The financial company's business operations and
assets will be sold off or liquidated, the culpable management
of the company will be discharged, shareholders will have their
investments wiped out, and unsecured creditors and
counterparties will bear losses.
There is a strong presumption that the bankruptcy process
will continue to be used to close and unwind failing financial
companies, including large, complex ones. The orderly
liquidation authority could be used if and only if the failure
of the financial company would threaten U.S. financial
stability. Therefore the threshold for triggering the orderly
liquidation authority is very high: (1) a recommendation by a
two thirds vote of the Board of the Governors of the Federal
Reserve System; (2) a recommendation by a two thirds vote of
the FDIC; (3) a determination and approval by the Secretary of
the Treasury after consultation with the President; and (4) a
review and determination by a judicial panel.
In order to protect taxpayers, large financial companies
will contribute $50 billion over a period of 5 to 10 years to a
fund held at the Treasury. This fund may only be used by the
FDIC in the orderly liquidation of a failing financial company
with the approval of the Treasury Secretary, and may not be
used for any other purpose. The FDIC must first rely on these
industry contributions if liquidity support is necessary to
safely unwind the failing financial company and prevent a
``fire sale'' of assets that could further threaten financial
stability. The fund would help avoid damaging ``pro-cyclical''
effects by allowing large financial companies to contribute
gradually when they can most afford to pay, not when a crisis
has already erupted. If additional liquidity is necessary, the
FDIC may obtain financing from the Treasury but only if such
financing can be repaid by the proceeds of the assets of the
failed financial company. Additional assessments on large
financial companies may be imposed if necessary to ensure 100
percent repayment of any funds obtained from the Treasury, and
any financial company that received payments greater than what
it otherwise would have received in bankruptcy will be assessed
at a substantially higher rate. Taxpayers will bear no losses
from the use of the orderly liquidation authority.
The Committee hearing record provides significant support
for establishing an orderly liquidation authority for large,
complex bank holding companies and nonbank financial companies.
On February 4, 2009, former Federal Reserve Chairman Paul
Volcker gave the recommendations of the ``Group of 30'' (an
international body of senior representatives from the public
and private sectors and academia dealing with economic and
financial issues), which included a call for U.S. legislation
to establish a regime to manage the resolution of failed non-
depository financial institutions comparable to the process for
depository institutions. The recommendations called for
applying this regime ``only to those few organizations whose
failure might reasonably be considered to pose a threat to the
financial system.''\9\ On June 18, 2009, Treasury Secretary
Timothy Geithner presented the Administration's financial
reform proposal, which called for a new authority modeled on
the FDIC's existing authority for banks and thrifts to address
the failure of a bank holding company or nonbank financial
company when the stability of the financial system is at risk.
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\9\Testimony of Paul Volcker, former Federal Reserve Board
Chairman, to the Banking Committee, February 4, 2009.
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In testimony submitted on July 23 of 2009, FDIC Chairman
Sheila Bair noted that large financial firms have been ``given
access to the credit markets at favorable terms without
consideration of the firms' risk profile. . . . Investors and
creditors believe their exposure is minimal since they also
believe the government will not allow these firms to fail.'' In
her July statement and in testimony on March 19 and May 6,
Chairman Bair discussed the limitations of current bankruptcy
procedures as applied to large and complex bank holding
companies and nonbank financial companies, and advocated for a
new statutory authority for the credible orderly unwinding of
such companies modeled on the FDIC's existing authorities.
Chairman Bair argued that the resolution authority must be able
to allocate losses among creditors in accordance with an
established claims priority ``where stockholders and creditors,
not the government, are in a first loss position.'' The
testimony also discussed the merits of building up a fund over
time in advance of a failure to provide working capital or to
cover unanticipated losses in an orderly liquidation.\10\ This
type of ``pre-funding'' would enable the government to impose
charges on large or complex financial companies consistent with
the risks they pose to the financial system, provide economic
incentives for a financial company against excessive and
dangerous growth, and avoid large charges during times of
economic stress that would have undesirable ``pro-cyclical''
effects.
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\10\Testimonies of Sheila Bair, Chairman of the Federal Deposit
Insurance Corporation, to the Banking Committee, March 19, May 6, and
July 23, 2009.
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In his July 23, 2009 testimony, Federal Reserve Board
Governor Daniel Tarullo also argued for a new resolution
authority as a ``third option between the choices of bankruptcy
and bailout.'' The testimony argued that allowing losses to be
imposed on creditors and shareholders ``is critical to
addressing the too-big-to-fail problem and the resulting moral
hazard effects.''\11\ Former Comptroller of the Currency Eugene
Ludwig also urged the Congress at a September 29, 2009 hearing
to create a new resolution function for large, complex
financial companies with financing provided by large financial
companies.\12\
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\11\Testimony of Daniel Tarullo, Federal Reserve Board Governor, to
the Banking Committee, July 23, 2009.
\12\Testimony of Eugene Ludwig, former Comptroller of the Currency,
to the Banking Committee, September 29, 2009.
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LIQUIDITY PROGRAMS
Title XI eliminates the ability of either the Federal
Reserve or the Federal Deposit Insurance Corporation to rescue
an individual financial firm that is failing, while preserving
the ability of both regulators to provide needed liquidity and
confidence in financial markets during times of severe
distress. That is to say, this Title ends the potential for
either regulator to come to the rescue of a future AIG, while
reconfiguring the weapons in their financial crisis arsenals to
increase accountability without diminishing their
effectiveness.
The Federal Reserve's emergency lending authority, under
section 13(3) of the Federal Reserve Act, in the past allowed
the Federal Reserve to make loans to individual entities like
AIG. While such lending played an important role in ending the
recent financial crisis, it also created potential moral
hazard. If the Federal Reserve were to retain authority to make
emergency loans to individual firms, then large, interconnected
firms might increase their risk-taking behavior, since the
Federal Reserve would be there to bail them out in a future
financial crisis.
By eliminating the ability to lend to individual
institutions, and by requiring all emergency lending to be done
through widely-available liquidity facilities that will be
approved by the Treasury, monitored through periodic reports to
Congress and by Comptroller General audits, and backed by
collateral sufficient to protect taxpayers from loss, emergency
lending by the Federal Reserve will not be a source of moral
hazard.
During the recent crisis the Federal Deposit Insurance
Corporation (FDIC) used the ``systemic risk exception'' to its
normal bank receivership rules to establish the Temporary
Liquidity Guarantee Program (TLGP) on an ad hoc basis.
By paying a TLGP insurance fee, federally insured
depositories and U.S. bank, financial and thrift holding
companies were able to issue unsecured short-term debt with a
federal government guarantee.\13\ Many firms used this program,
and its existence helped them to roll over needed short-term
financing after a period in which the outstanding volume of
financial commercial paper contracted sharply and discount
rates spiked upward.\14\ At its peak usage level in May 2009
the TLGP insured approximately $345 billion in outstanding
debt. As of December 2009 the debt guarantee program had
assessed $10.3 billion in guarantee fees.\15\
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\13\The fees charged increase with the maturity of the debt, rising
from 12.5 basis points for three-month debt to 100 basis points for
debt with maturities of one year or more, with additional charges added
under certain conditions. Eligible entities include: (1) FDIC-insured
depository institutions; (2) U.S. bank holding companies; (3) U.S.
financial holding companies; and (4) U.S. savings and loan holding
companies that either engage only in activities that are permissible
for financial holding companies under section 4(k) of the Bank Holding
Company Act (BHCA) or have an insured depository institution subsidiary
that is the subject of an application under section 4(c)(8) of the BHCA
regarding activities closely related to banking. See http://
www.fdic.gov/regulations/resources/tlgp/index.html.
\14\For data on outstanding volumes of financial commercial paper
and discount rates for AA financial commercial paper see http://
www.federalreserve.gov/releases/cp/.
\15\For data on outstanding volumes guaranteed see http://
www.fdic.gov/regulations/
resources/tlgp/reports.html.
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Under the TLGP, the FDIC also established a program to
guarantee non-interest bearing transaction accounts that exceed
the deposit insurance limit. Participating insured depositories
pay an annualized risk-based assessment ranging from 15 to 25
basis points on transaction account amounts that exceed the
current FDIC insurance amount of $250,000.
This Title allows the FDIC to guarantee short-term debt
during financial crises, but limits the guarantees to solvent
banks and bank holding companies, restricts the conditions
under which such support may be offered, increases
accountability of the guarantee program, and eliminates the
possibility that taxpayers will pay for any losses from the
program.
Under this Title no guarantee can be offered unless the
Board of Governors of the Federal Reserve and the FDIC jointly
agree that a liquidity event--essentially a breakdown in the
ability of borrowers to access credit markets in a normal
fashion--exists. The FDIC may then set up a facility to
guarantee debt, following policies and procedures determined by
regulation. The regulation is to be written in consultation
with the Treasury. The terms and conditions of the guarantees
must be approved by the Secretary of the Treasury.
The Secretary will determine a maximum amount of
guarantees, and the President will request Congress to allow
that amount. If the President does not submit the request, the
guarantees will not be made. Congress has 5 days under an
expedited procedure to disapprove the request. Fees for the
guarantees are set to cover all expected costs. If there are
losses, they are recouped from those firms that received
guarantees. Firms that default on guarantees will be put into
receivership, resolution or bankruptcy. Any FDIC aid to an
individual firm under the ``systemic risk exception'' will
henceforth only be possible if the firm has been placed in
receivership, and therefore the FDIC will no longer be able to
provide ``open bank assistance'' using this exception.
Hence FDIC debt guarantees will be available to help ease
liquidity problems during financial crises, but will not be a
source of moral hazard since the FDIC may guarantee only the
debt of solvent institutions. Moreover, taxpayers are protected
from any loss by the recoupment requirements.
Title XI also makes important changes to Federal Reserve
governance. It establishes the position of Vice Chairman for
Supervision on the Federal Reserve Board of Governors. The Vice
Chairman will have the responsibility to develop policy
recommendations on supervision and regulation for the Board,
and will report twice each year to Congress. The Federal
Reserve is also given formal responsibility to identify,
measure, monitor, and mitigate risks to U.S. financial
stability. In addition, the Federal Reserve is formally
prohibited from delegating its functions for establishing
regulatory or supervisory policy to Federal Reserve banks.
To eliminate potential conflicts of interest at Federal
Reserve banks, the Federal Reserve Act is amended to state that
no company, or subsidiary or affiliate of a company, that is
supervised by the Board of Governors can vote for Federal
Reserve Bank directors; and the officers, directors and
employees of such companies and their affiliates cannot serve
as directors. In addition, to increase the accountability of
the Federal Reserve Bank of New York president, who plays a key
role in formulating and executing monetary policy, this reserve
bank officer will be appointed by the President, by and with
the advice and consent of the Senate, rather than by the bank's
board of directors.
``THE VOLCKER RULE''
Section 619 of Title VII prohibits or restricts certain
types of financial activity--in banks, bank holding companies,
other companies that control an insured depository institution,
their subsidiaries, or nonbank financial companies supervised
by the Board of Governors--that are high-risk or which create
significant conflicts of interest between these institutions
and their customers.
Banks, bank holding companies, other companies that control
an insured depository institution, their subsidiaries, or
nonbank financial companies supervised by the Board of
Governors will be prohibited from proprietary trading,
sponsoring and investing in hedge funds and private equity
funds, and from having certain financial relationships with
those hedge funds or private equity funds for which they serve
as investment manager or investment adviser. A nonbank
financial institution supervised by the Board of Governors that
engages in proprietary trading, or sponsoring or investing in
hedge funds and private equity funds will be subject to Board
rules imposing capital requirements related to, or quantitative
limits on, these activities.\16\
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\16\These firms will be supervised by the Board of Governors
because their failure could threaten overall financial stability.
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The incentive for firms to engage in these activities is
clear: when things go well, high-risk behavior can produce high
returns. In good times these profits allow firms to grow
rapidly, and encourage additional risk-taking. However, when
things do not go well, these same activities can produce
outsize losses.
When losses from high-risk activities are significant, they
can threaten the safety and soundness of individual firms and
contribute to overall financial instability. Moreover, when the
losses accrue to insured depositories or their holding
companies, they can cause taxpayer losses. In addition, when
banks engage in these activities for their own accounts, there
is an increased likelihood that they will find that their
interests conflict with those of their customers.
The prohibitions in section 619 therefore will reduce
potential taxpayer losses at institutions protected by the
federal safety net, and reduce threats to financial stability,
by lowering their exposure to risk. Conflicts of interest will
be reduced, for example, by eliminating the possibility that
firms will favor inside funds when placing funds for clients.
The prohibitions also will prevent firms protected by the
federal safety net, which have a lower cost of funds, from
directing those funds to high-risk uses. Moreover, they will
restrict high-risk activity in those nonbank financial firms
that pose threats to financial stability.
The prohibitions also will reduce the scale, complexity,
and interconnectedness of those banks that are now actively
engaged in proprietary trading, or have hedge fund or private
equity exposure. They will reduce the possibility that banks
will be too big or too complex to resolve in an orderly manner
should they fail.
In testimony submitted to the Committee, Neal Wolin, Deputy
Secretary of the Treasury, stated that ``Proprietary trading,
by definition, is not done for the benefit of customers or
clients. Rather, it is conducted solely for the benefit of the
bank itself. It is therefore difficult to justify an
arrangement in which the federal safety net redounds to the
benefit of such activities.'' Wolin noted that the role of
proprietary trading and ownership of hedge funds, and their
associated high risk, contributed to the crisis when banks were
forced to bail out those operations. Wolin testified, ``Major
firms saw their hedge funds and proprietary trading operations
suffer large losses in the financial crisis. Some of these
firms `bailed out' their troubled hedge funds, depleting the
firm's capital at precisely the moment it was needed
most.''\17\
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\17\Testimony by Neal Wolin, Deputy Secretary of the Treasury, to
the Senate Banking Committee, 2/2/10.
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Paul Volcker, former Federal Reserve Board Chairman,
discussed the benefits to the market from the prohibition and
the impact on systemic risk: ``Curbing the proprietary
interests of commercial banks is in the interest of fair and
open competition as well as protecting the provision of
essential financial services.'' Volcker added that the proposal
was ``particularly designed to help deal with the problem of
``too big to fail' and the related moral hazard that looms so
large as an aftermath of the emergency rescues of financial
institutions[.]''\18\
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\18\Testimony by Paul Volcker, former Federal Reserve Board
Chairman and Chairman of the President's Economic Recovery Advisory
Board, to the Senate Banking Committee, 2/2/10.
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THE BUREAU OF CONSUMER FINANCIAL PROTECTION
The Committee has documented in numerous hearings over the
years the failure of the federal banking and other regulators
to address significant consumer protection issues detrimental
to both consumers and the safety and soundness of the banking
system.\19\ These failures, which are described in more detail
below, led to what has become known as the Great Recession in
which millions of Americans have lost jobs; millions of
American families have lost trillions of dollars in net worth;
millions of Americans have lost their homes; and millions of
Americans have lost their retirement, college, and other
savings.
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\19\``The need could not be clearer. Today's consumer protection
regime just experienced massive failure. It could not stem a plague of
abusive and unaffordable mortgages and exploitative credit cards
despite clear warning signs. It cost millions of responsible consumers
their homes, their savings, and their dignity. And it contributed to
the near-collapse of our financial system. We did not have just a
financial crisis; we had a consumer crisis.'' Testimony of Michael
Barr, Assistant Secretary of the Treasury for Financial Institutions,
to the Senate Committee on Banking, Housing, and Urban Affairs, July
14, 2009.
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Structural Problems with Current Consumer Regulation
The current system of consumer protection suffers from a
number of serious structural flaws that undermine its
effectiveness, including a lack of focus resulting from
conflicting regulatory missions, fragmentation, and regulatory
arbitrage.
To begin with, placing consumer protection regulation and
enforcement within safety and soundness regulators does not
lead to better coordination of the two functions, as some would
argue. As has been made amply apparent, when these two
functions are put in the same agency, consumer protection fails
to get the attention or focus it needs. Protecting consumers is
not the banking agencies' priority, nor should it be. The
primary mission of these regulators ``in law and practice,'' as
Assistant Secretary of the Treasury Michael Barr testified, is
to ensure the safe and sound operations of the banks. Because
of this, former Director of the Office of Thrift Supervision
(OTS) Ellen Seidman testified, ``[consumer] compliance has
always had a hard time competing with safety and soundness for
the attention of regulators. . . .''\20\ In fact, as Assistant
Secretary Barr pointed out, bank regulators conduct consumer
protection supervision with an eye toward bank safety and
soundness by, for example, trying to protect the banks from
reputation and litigation risks rather than examining how
products and services affect consumers. ``Managing risks to the
bank does not and cannot protect consumers effectively. This
approach judges a bank's conduct toward consumers by its effect
on the bank, not . . . on consumers.''\21\
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\20\Testimony of Ellen Seidman, former Director of the Office of
Thrift Supervision, to the Banking Committee, March 2, 2009.
\21\Testimony of Michael Barr, July 14, 2009.
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This may lead, as some witnesses before the Committee
testified, to an emphasis by the regulators on the short term
profitability of the banks at the expense of consumer
protection.\22\
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\22\Testimony of Patricia McCoy, George J. and Helen M. England
Professor of Law, University of Connecticut to the Banking Committee,
hearing on March 3, 2009 and testimony of Travis Plunkett, Legislative
Director of the Consumer Federation of America to the Banking
Committee, July 14, 2009.
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The current system is also too fragmented to be effective.
There are seven different federal regulators involved in
consumer rule writing or enforcement. Gene Dodaro, Acting
Comptroller General, testified that ``the fragmented U.S.
regulatory structure contributed to failures by the existing
regulators to adequately protect consumers and ensure financial
stability.''\23\ This undermines accountability.
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\23\Testimony of Gene Dodaro, Acting Comptroller General of the
United States, February 4, 2009.
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This fragmentation led to regulatory arbitrage between
federal regulators and the states, while the lack of any
effective supervision on nondepositories led to a ``race to the
bottom'' in which the institutions with the least effective
consumer regulation and enforcement attracted more business,
putting pressure on regulated institutions to lower standards
to compete effectively, ``and on their regulators to let
them.''\24\
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\24\Testimony of Michael Barr, July 14, 2009.
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A More Effective Approach
This legislation creates the Bureau of Consumer Financial
Protection (CFPB), a new, streamlined independent consumer
entity housed within the Federal Reserve System. The CFPB will
be focused on ensuring that consumers get clear and effective
disclosures in plain English and in a timely fashion so that
they will be empowered to shop for and choose the best consumer
financial products and services for them.
The new CFPB will establish a basic, minimum federal level
playing field for all banks and, for the first time,
nondepository financial companies that sell consumer financial
products and services to American families. It will do so
without creating an undue burden on banks, credits unions, or
nondepository providers of these products and services.
The CFPB will help protect consumers from unfair,
deceptive, and abusive acts that so often trap them in
unaffordable financial products. The CFPB will stop regulatory
arbitrage. It will write rules and enforce those rules
consistently, without regard to whether a mortgage, credit
card, auto loan, or any other consumer financial product or
service is sold by a bank, a credit union, a mortgage broker,
an auto dealer, or any other nondepository financial company.
This way, a consumer can shop and compare products based on
quality, price, and convenience without having to worry about
getting trapped by the fine print into an abusive deal.
The legislation ends the fragmentation of the current
system by combining the authority of the seven federal agencies
involved in consumer financial protection in the CFPB, thereby
ensuring accountability.
The CFPB will have enough flexibility to address future
problems as they arise. Creating an agency that only had the
authority to address the problems of the past, such as
mortgages, would be too short-sighted. Experience has shown
that consumer protections must adapt to new practices and new
industries.
Mortgage Crisis
The fundamental story of the current turmoil is
relatively easy to tell. It began early in this decade
with a weakening of underwriting standards for subprime
mortgages in the U.S. Subprime, alt-A and other
mortgage products [which] were sold to people who could
not afford them and in some cases in violation of legal
standards.\25\
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\25\Testimony of Eugene Ludwig to the Banking Committee, October
16, 2008.
---------------------------------------------------------------------------
--Eugene Ludwig
This financial crisis was precipitated by the proliferation
of poorly underwritten mortgages with abusive terms, followed
by a broad fall in housing prices as those mortgages went into
default and led to increasing foreclosures. These subprime and
nontraditional mortgages were characterized by relatively low
initial interest rates that allowed borrowers to obtain loans
for which they might not otherwise qualify.\26\ However, after
2 or 3 years, the rates would jump up significantly--by as much
as 30 to 40 percent or more, according to the testimony of
Michael Calhoun, President of the Center for Responsible
Lending (CRL).\27\ The great majority of the payment-option
adjustable rate mortgages (option ARMs) resulted in significant
negative amortization, so that many borrowers owed more on
their mortgages after several years than when the mortgages
were initially sold.
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\26\It is important to note that the vast majority of subprime
mortgages were used to refinance existing mortgages rather than to
purchase a home. According to data collected by the Center for
Responsible Lending (``Subprime Lending: A Net Drain on
Homeownership,'' CRL Issue Paper #14, March 27, 2007), 62% of subprime
loans made from 1998 through 2006 were refinances; only 9% were for
first time home purchase loans (11% in 2006 was the highest figure). In
other words, even before the foreclosure crisis hit, subprime loans did
not make a substantial contribution to new homeownership. Rather, they
put existing homeowners at greatly increased risk of losing their
homes. Indeed, according to CRL, as of early 2007, there was a net loss
in homeownership of over 900,000 households, a figure that has
certainly increased greatly since the CRL paper was written. FDIC Vice
Chair Marty Gruenberg made this point in a speech in New York on
January 8, 2008, when he said:
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``[i]t has been said that a lot of these homes were
bought on a speculative basis and people who did that don't
deserve help. That is true of some. But it is important to
understand that the majority of subprime mortgages were
refinancings of existing homes. In other words, these were
homes in which the homeowner was living, with mortgages
that the homeowner was paying and could afford. In many
cases the homeowner was encouraged or induced to refinance
into one of these subprime mortgages with exploding
interest rates that the homeowner couldn't afford.
---------------------------------------------------------------------------
\27\Testimony of Michael Calhoun, President of the Center for
Responsible Lending, to the Subcommittee on Housing, Transportation,
and Community Development of the Banking Committee, June 26, 2007.
---------------------------------------------------------------------------
According to testimony heard in the Committee in late
2006,\28\ and again in early 2007,\29\ many of these loans were
made with little or no regard for a borrower's understanding of
the terms of, or their ability to repay, the loans. At a
September 20, 2006 Subcommittee hearing, Subcommittee Chairman
Bunning said ``it is not clear that borrowers understand [the]
risks'' associated with these mortgages, a conclusion borne out
both by a study by the Federal Reserve Board and the Consumer
Federation of America (CFA). As Allen Fishbein, then Director
of Housing Policy at the CFA, testified:
---------------------------------------------------------------------------
\28\The Housing and Transportation and Economic Policy
Subcommittees of the Banking Committee held two hearings on the issues
arising from the increase in nontraditional mortgage lending: September
13, 2006 and September 20, 2006.
\29\See Banking Committee Hearings on February 7 and March 22,
2007.
Consumers today face a dizzying array of mortgage
products that are marketed and promoted under a range
of products names. While the number of products has
exploded, there appears to be little understanding by
many borrowers about key features in today's mortgages
and how to compare or even understand the differences
between these products.
A 2004 Consumer Federation of America survey found
that most consumers cannot calculate the payment change
for an adjustable rate mortgage. . . . all respondents
underestimated the annual increase in the cost of
monthly mortgage payments if the interest rate
[increased] from 6 percent to 8 percent. . . . Younger,
poorer, and less formally educated respondents
underestimated by as much as 50 percent.\30\
---------------------------------------------------------------------------
\30\Testimony of Allen Fishbein, Director of Housing Policy at the
Consumer Federation of America, to the joint Subcommittees, September
20, 2006. Mr. Fishbein is currently Assistant Director for Policy
Analysis, Consumer Education and Research at the Federal Reserve Board.
Fishbein also cited a Federal Reserve study of ARM
borrowers that found that 35 percent of them did not know the
maximum amount their interest rate could increase at one time;
44 percent did not know the maximum rate they could be charged;
and 17 percent did not know the frequency with which the rate
could change.\31\
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\31\Testimony to the joint Subcommittee hearing, September 20, 2006
citing January, 2006 Federal Reserve Study, written by Brian Buck and
Karen Pence, ``Do Homeowners Know Their House Values and Mortgage
Terms?''
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Finally, Fishbein cited a focus group of exotic mortgage
borrowers organized by Public Opinion Strategies. It found that
these consumers were ``surprised by the magnitude of the
payment shock'' once rate sheets with the various mortgage
option terms were shown to them. Lower-income borrowers, in
particular, called the payment increases ``shocking.'' Fishbein
explained that these lower-income borrowers ``were less
informed about the payment increases and debt risks of non-
traditional mortgages, with some noting they ``wish they had
known more.'''\32\
---------------------------------------------------------------------------
\32\Testimony of Allen Fishbein, September 20, 2006.
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In that same hearing, Senator Sarbanes said that:
Too often . . . loans have been made without the
careful consideration as to the long-term
sustainability of the mortgage. Loans are being made
without the lender documenting that the borrower will
be able to afford the loan after the expected payment
shock hits without depending on rising incomes or
increased appreciation.
Several months later, as the problem worsened, Chairman
Dodd noted in a March 22, 2007 hearing that:
. . . a sort of frenzy gripped the market over the past
several years as many [mortgage] brokers and lenders
started selling these complicated mortgages to low-
income borrowers, many with less than perfect credit,
who they knew or should have known . . . would not be
able to afford to repay these loans when the higher
payments kicked in. (emphasis added).
Underscoring this point, the General Counsel of Countrywide
Financial Corporation, one of the biggest subprime lenders in
2007, acknowledged in response to a question from Chairman Dodd
that ``about 60 percent of the people who do qualify for the
hybrid ARMs would not be able to qualify at the fully indexed
rate''\33\ (that is, at the rate a borrower would have to pay
after the loan reset, even assuming interest rates did not
rise). Another witness, Jennie Haliburton, an elderly resident
of Philadelphia, Pennsylvania who lived on a fixed income of
social security benefits, had been sold such a mortgage and was
facing a jump in her mortgage payment to 70 percent of her
income. The Department of Housing and Urban Development
considers payments by consumers of more than 50% of income for
shelter to put those consumers at ``high risk'' of losing their
homes.
---------------------------------------------------------------------------
\33\See Banking Committee hearings on March 22, 2008.
---------------------------------------------------------------------------
This testimony clearly demonstrates that the lenders were
aware that borrowers would need to refinance their loans or
sell their homes when the mortgages reset, thereby generating
additional fees for the brokers and lenders. This was, in the
words of Martin Eakes, Chief Operating Officer of the Self-Help
Credit Union, ``a devil's choice.''\34\
---------------------------------------------------------------------------
\34\Testimony of Martin Eakes, Chief Operating Officer of the Self-
Help Credit Union, to the Committee, February 7, 2007.
---------------------------------------------------------------------------
The Committee heard some discussion as to what institutions
were most responsible for originating these loans. There is
little doubt that nondepository financial companies were among
the largest sellers of subprime and exotic mortgages. However,
insured depositories and their subsidiaries were heavily
involved in these markets. According to data compiled by
Federal Reserve Board Economists, 36 percent of all higher-
priced loans in 2005 and 31 percent in 2006 were made by
insured depositories and their subsidiaries. Those numbers jump
to 48 percent and 44 percent when bank affiliates are
included.\35\ This illustrates that being under the supervision
of a federal prudential regulator did not guarantee that
mortgage underwriting practices were any stronger, or consumer
protections any more robust. As noted, the regulators allowed
this deterioration in underwriting standards to take place in
part to prevent the institutions they regulate from getting
priced out of the market.
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\35\Neil Bhutta and Glenn Canner, ``Did CRA Cause the Mortgage
Market Meltdown,'' Federal Reserve Bank of Minneapolis, March 9, 2009.
---------------------------------------------------------------------------
Unfortunately, many of these mortgages were packaged by big
Wall Street banks into mortgage-backed securities (MBS) and
sold in pieces all over the world. Because of the unaffordable
and abusive terms of the loans, these mortgages became
delinquent at the highest rates since mortgage performance data
started being collected over 30 years ago, leading, in turn, to
increasing foreclosures, decreasing housing demand, and a
widespread decline in housing prices. Once housing prices fell,
families who might otherwise have been able to refinance their
mortgages were unable to do so because they found themselves
``underwater,'' owing more on their mortgages than the home is
worth at that time.
As a result, the MBS into which these now non-performing
mortgages were bundled lost significant value, helping lead to
the systemic collapse from which we are currently suffering.
Effect on Minorities
The mortgage lending system is deeply flawed. . . .
The crisis is having a disproportionate impact on
African American families, Latino families, low income
families. And that disproportionate impact is not
explained away by factors that would ordinarily justify
such a problem.\36\
---------------------------------------------------------------------------
\36\Testimony of Wade Henderson, President and CEO of the
Leadership Conference on Civil Rights, to the Subcommittee on Housing,
Transportation, and Community Development hearing, June 26, 2007.
---------------------------------------------------------------------------
--Wade Henderson
Regrettably, the Committee heard a lot of testimony
outlining how mortgage originators targeted minorities for
subprime mortgages even when these borrowers might have
qualified for lower cost prime mortgages. In fact, according to
a study conducted by the Wall Street Journal, as many as 61
percent of those receiving subprime loans ``went to people with
credit scores high enough to often qualify for conventional
loans with far better terms.''\37\ Under the Home Mortgage
Disclosure Act (HMDA), the Federal Reserve collects data on
``high cost'' mortgage lending, defined as mortgage loans which
are 3 points above the Treasury rate. According to HMDA data
released in 2007 by the Federal Reserve, 54 percent of African-
Americans and 47 percent of Hispanics received high cost
mortgages in 2006. Only 18 percent of non-Hispanic whites
received high cost mortgages. The Federal Reserve study found
that borrower related factors, such as income, accounted for
only one sixth of this disparity. CRL did a study of the 2004
HMDA data which controls for other significant risk factors
used to determine loan pricing, such as income and credit
scores. The CRL study found that African-Americans were more
likely to receive higher-rate home-purchase and refinance loans
than similarly-situated white borrowers, and that Latino
borrowers were more likely to receive higher-rate home purchase
loans than similarly-situated non-Latino white borrowers.\38\
---------------------------------------------------------------------------
\37\``Subprime Debacle Traps Even Very Credit-Worthy, Wall Street
Journal, December 3, 2007.
\38\CRL, ``Unfair Lending: The Effect of Race and Ethnicity on the
Price of Subprime Mortgages,'' May 31, 2006.
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Failure of the Safety and Soundness Regulators
It has become clear that a major cause of the most
calamitous worldwide recession since the Great
Depression was the simple failure of federal regulators
to stop abusive lending, particularly unsustainable
home mortgage lending.\39\
---------------------------------------------------------------------------
\39\Testimony of Travis Plunkett, Legislative Director of the
Consumer Federation of America to the Banking Committee, July 14, 2009.
---------------------------------------------------------------------------
--Travis Plunkett
Underlying this whole chain of events leading to the
financial crisis was the spectacular failure of the prudential
regulators to protect average American homeowners from risky,
unaffordable, ``exploding'' adjustable rate mortgages, interest
only mortgages, and negative amortization mortgages. These
regulators ``routinely sacrificed consumer protection for
short-term profitability of banks,''\40\ undercapitalized
mortgage firms and mortgage brokers, and Wall Street investment
firms, despite the fact that so many people were raising the
alarm about the problems these loans would cause.
---------------------------------------------------------------------------
\40\Testimony of Patricia McCoy to the Banking Committee, March 3,
2009.
---------------------------------------------------------------------------
In 1994, Congress enacted the ``Home Ownership and Equity
Protection Act'' (HOEPA) which states that:
the Board, by regulation or order, shall prohibit acts
or practices in connection with--
(a) Mortgage loans that the Board finds to be unfair,
deceptive, or designed to evade the provisions of this
section; and
(b) Refinancing of mortgage loans that the Board
finds to be associated with abusive lending practices
or that are otherwise not in the interests of borrower.
As early as late 2003 and early 2004, Federal Reserve staff
began to ```observe deterioration of credit standards''' in the
origination of non-traditional mortgages.\41\ Yet, the Federal
Reserve Board failed to meet its responsibilities under HOEPA,
despite persistent calls for action.
---------------------------------------------------------------------------
\41\Banking Committee document, ``Mortgage Market Turmoil: A
Chronology of Regulatory Neglect'' prepared by the staff of the Banking
Committee, March 22, 2007.
---------------------------------------------------------------------------
As Professor McCoy noted in her testimony to the Committee,
``federal banking regulators added fuel to the crisis by
allowing reckless loans to flourish.'' Professor McCoy points
out that the regulators had ``ample authority'' to prohibit
banks from extending credit without proof of a borrower's
ability to pay. Yet, she notes, ``they refused to exercise
their substantial powers of rule-making, formal enforcement,
and sanctions to crack down on the proliferation of poorly
underwritten loans until it was too late.''\42\
---------------------------------------------------------------------------
\42\Testimony to the Banking Committee, March 3, 2009.
---------------------------------------------------------------------------
Finally, in July of 2008, long after the marketplace had
shut down the availability of subprime and exotic mortgage
credit, and much of prime mortgage credit not directly
supported by federal intervention, the Federal Reserve Board
issued rules that would likely prevent a repeat of the same
kinds of problems that led to the current crisis.
Where federal regulators refused to act, the states stepped
into the breach. In 1999, North Carolina became the first State
to enact a comprehensive anti-predatory law. Other States
followed suit as the devastating results of predatory mortgage
lending became apparent through increased foreclosures and
disinvestment.
Unfortunately, rather than supporting these anti-predatory
lending laws, federal regulators preempted them. In 1996, the
OTS preempted all State lending laws. The OCC promulgated a
rule in 2004 that, likewise, exempted all national banks from
State lending laws, including the anti-predatory lending laws.
At a hearing on the OCC's preemption rule, Comptroller Hawke
acknowledged, in response to questioning from Senator Sarbanes,
that one reason Hawke issued the preemption rule was to attract
additional charters, which helps to bolster the budget of the
OCC.\43\
---------------------------------------------------------------------------
\43\Banking Committee hearing, April 7, 2004.
---------------------------------------------------------------------------
Two recent studies by the Center for Community Capital at
the University of North Carolina document the damage created by
this preemption regulation. The two studies found that:
(1) States with strong anti-predatory lending laws
exhibited significantly lower foreclosure risk than
other States. A typical State law reduced neighborhood
default rates by as much as 18 percent;
(2) Loans made by lenders covered by tougher State
laws had fewer risky features and better underwriting
practices to ensure that borrowers could repay;
(3) Mortgage defaults increased more significantly
among exempt OCC lenders in States with strong anti-
predatory lending laws than among lenders that were
still subject to tougher State laws. For example,
default rates of fixed-rate refinance mortgages made by
national banks not subject to State laws were 41
percent more likely to default and purchase-money
mortgages made by these banks were 7 percent more
likely to default than loans those banks made prior to
preemption; and
(4) Risky lending by national banks more than doubled
in some loan categories (fixed-rate refinances) after
preemption than before, 11 percent to 29 percent.\44\
---------------------------------------------------------------------------
\44\``The APL Effect: The Impacts of State Anti-Predatory Lending
Laws on Foreclosures,'' by Lei Ding, et al; University of North
Carolina, March 23, 2010 and ``The Preemption Effect: The Impact of
Federal Preemption of State Anti-Predatory Lending Laws on the
Foreclosure Crisis,'' by Lei Ding et al, March 23, 2010.
In remarkably prescient testimony, Martin Eakes warned in
2004 that the OCC's action on preemption ``plants the seeds for
long-term trouble in the national banking system.'' He went on
---------------------------------------------------------------------------
to say:
Abusive practices may well be profitable in the short
term, but are ticking time bombs waiting to explode the
safety and soundness of national banks in the years
ahead. The OCC has not only done a tremendous
disservice to hundreds of thousands of borrowers, but
has also sown the seeds for future stress on the
banking system.\45\
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\45\Testimony of Martin Eakes to the Banking Committee, April 7,
2004.
In sum, the Federal Reserve and other federal regulators
failed to use their authority to deal with mortgage and other
consumer abuses in a timely way, and the OCC and the OTS
actively created an environment where abusive mortgage lending
could flourish without State controls.
Other Consumer Financial Products and Services
Though the problems in the mortgage market have received
most of the public's attention, consumers have long faced
problems with many other consumer financial products and
services without adequate federal rules and enforcement.
Abusive lending, high and hidden fees, unfair and deceptive
practices, confusing disclosures, and other anti-consumer
practices have been a widespread feature in commonly available
consumer financial products such as credit cards. These
problems have been documented in numerous hearings before the
Banking Committee and other Congressional Committees over the
years.
Credit Cards. For example, credit card companies have long
been known to provide extremely confusing disclosures, making
it nearly impossible for consumers to understand the terms for
which they are signing up. Card companies have engaged in
extremely aggressive marketing, such that from 1999 to 2007
creditor marketing and credit extension increased at about two
times the rate as credit card debt taken on by consumers.\46\
---------------------------------------------------------------------------
\46\Testimony of Travis Plunkett to the Banking Committee, February
12, 2009.
---------------------------------------------------------------------------
Moreover, typical credit card companies and banks engaged
in a number of abusive pricing practices, including double-
cycle billing, universal default, retroactive changes in
interest rates, over the limit fees even where the consumer was
not notified that a charge put him or her over the allotted
credit limit, and arbitrary rate increases.
Despite the growing problems, federal banking regulators
did very little. As Adam Levitin, Associate Professor of Law at
Georgetown University Law Center explained to the Committee at
a February, 2009 hearing,
The current regulatory regime for credit cards is
inadequate and incapable of keeping pace with credit
card industry innovation. The agencies with
jurisdiction over credit cards lack regulatory
motivation and have conflicting missions. . . .\47\
---------------------------------------------------------------------------
\47\Testimony of Levitin, Associate Professor of Law at Georgetown
University Law Center to the Banking Committee, February 12, 2009.
To illustrate this point, research shows that from 1997 to
2007 the OCC took just 9 formal enforcement actions regarding
violations of the Truth in Lending Act with regards to credit
cards or other consumer lending.\48\ In fact, the Comptroller
of the Currency wrote a letter objecting to certain parts of
the Federal Reserve Board's proposed regulation on credit cards
on safety and soundness grounds.\49\
---------------------------------------------------------------------------
\48\Testimony of Michael Calhoun to the U.S. House of
Representatives Committee on Financial Services, September 30, 2009.
\49\Letter from Comptroller of the Currency John Dugan to the Board
of Governors of the Federal Reserve System, August 18, 2008.
---------------------------------------------------------------------------
Even after President Obama signed the Credit Card
Accountability, Responsibility, and Disclosures Act (CARD Act)
into law, credit card companies sought ways to structure
products to get around the new rules, highlighting the
difficulty of combating new problems with additional laws,
while underscoring the importance of creating a dedicated
consumer entity that can respond quickly and effectively to
these new threats to consumers.
Overdrafts. Similar problems have been revealed by the
Committee's examination of overdraft fees.\50\ Overdraft
coverage for a fee is a form of short term credit that
financial institutions extend to consumers to cover overdrafts
on check, ACH, debit and AMT transactions. Historically,
financial institutions covered overdrafts for a fee on an ad
hoc basis. With the growth in specially designed software
programs and in consumer use of debit cards, overdraft coverage
for a fee has become more prevalent.
---------------------------------------------------------------------------
\50\Banking Committee hearing, November 17, 2009.
---------------------------------------------------------------------------
A consumer normally qualifies for overdraft coverage if his
or her account has been open for a specified period (usually
six months), and there are regular deposits into the account.
If those criteria are met, most financial institutions
automatically enroll consumers in overdraft coverage without
the consumer's knowledge or choice. ``Consumers do not apply
for . . . this credit, do not receive information on the cost
to borrow [these funds], are not warned when a transaction is
about to initiate an overdraft, and are not given the choice of
whether to borrow the funds at an exorbitant price or simply
cancel the transaction.''\51\
---------------------------------------------------------------------------
\51\Testimony of Jean Ann Fox, Director of Financial Services at
Consumer Federation of America to the Banking Committee, November 17,
2009.
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Once overdraft coverage for a fee has been added to an
account, some financial institutions do not allow consumers the
option of eliminating the coverage, although other more
consumer friendly alternatives like overdraft lines of credit
or linking checking and savings accounts are available.
Many consumers who are enrolled in these programs without
their knowledge find themselves subject to high fees of up to
$35 per transaction even if the overdraft is only a few cents.
In some cases, consumers have been charged multiple fees in one
day without being notified until days later. Most institutions
also charge an additional fee for each day the account remains
overdrawn. Some financial institutions will even re-arrange the
order in which they process purchases, charging for a later,
larger purchase first so that they can charge repeated
overdraft coverage fees for earlier, smaller purchases.
The result has been that American consumers paid $24
billion in overdraft fees in 2008\52\ and $38.5 billion in
overdraft fees in 2009.\53\ CRL also found that nearly $1
billion of those fees would come from young adults and that
$4.5 billion would come from senior citizens.
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\52\Testimony of Michael Calhoun, November 17, 2009.
\53\Julianne Pepitone, ``Bank overdraft fees to total $38.5
billion,'' CNNMoney.com, http://money.cnn.com/2009/08/10/news/
companies/bank_overdraft_fees_Moebs/index.htm. August 10, 2009.
---------------------------------------------------------------------------
In addition, the Federal Deposit Insurance Corporation
(FDIC) found that a small percentage (12%) of consumers
overdraw their account five times per year or more. For these
consumers, overdraft coverage is a form of high cost short term
credit similar to a payday loan. For example, a consumer
repaying a $20 point of sale debit overdraft in two weeks is
effectively paying an APR of 3,520%.\54\
---------------------------------------------------------------------------
\54\FDIC Study of Bank Overdraft Programs, November, 2008.
---------------------------------------------------------------------------
For many years, the Federal Reserve and other regulators
have been aware of the abusive nature of overdraft coverage
programs. In fact, an Interagency Guidance in 2005 called
overdraft coverage programs ``abusive and misleading.''
Nonetheless, the Federal Reserve has only issued modest rule
after modest rule to address these programs. Despite years of
concerns raised, it was not until November of last year that
the Federal Reserve adopted another modest rule on overdraft
coverage that would prohibit financial institutions from
charging any consumer a fee for overdrafts on ATM and debit
card transactions, unless the consumer opts in to the overdraft
service for those types of transactions. Much more needs to be
done in this area to protect consumers and rein in abusive
practices.
Debt Collection. The Committee has similar concerns
regarding the record of abusive, deceptive and unfair practices
by debt collectors. The Fair Debt Collection Practices Act
(FDCPA) was passed by Congress to regulate debt collection
activities and behavior, but despite the existence of the act,
debt collection abuses proliferate. In the last five years,
consumers have filed nearly half a million complaints with the
Federal Trade Commission about debt collection practices. These
complaints include numerous reports of behavior in violation of
the act, including: debt collectors threatening violence, using
profane or harassing language, bombarding consumers with
continuous calls, telling neighbors or family about what is
owed, calling late at night, and falsely threatening arrest,
seizure of property or deportation. The FTC receives more
complaints from consumers about debt collectors than any other
industry. Despite these complaints, in the last five years, the
FTC has only filed nine debt collection cases.
In addition to concerns about debt collection tactics, the
Committee is concerned that consumers have little ability to
dispute the validity of a debt that is being collected in
error. The FDCPA provides that, if a consumer disputes a debt,
the collector is required to obtain verification of the debt
and provide it to the consumer before renewing its collection
efforts. The FDCPA does not, however, specify what constitutes
``verification of the debt,'' with the result that many
collectors currently do little more than confirm that their
information accurately reflects what they received from the
creditor. The limited information debt collectors obtain in
verifying debts is unlikely to dissuade them from continuing
their attempts to collect from the wrong consumer or the wrong
amount, so that an aggrieved consumer has virtually no
protection against erroneous efforts to collect.
Debt collectors who are unsuccessful in collecting on a
debt may use attorneys to file frequent lawsuits that they are
not prepared to litigate, and which may not be factually valid,
with the expectation that a large number of consumers will
default or will not be prepared to defend themselves. Abuses in
these suits have been documented in numerous press reports\55\
and by the FTC as well as by consumer advocates. The FTC found
that ``the vast majority of debt collection suits filed in
recent years has posed considerable challenges to the smooth
and efficient operations of the courts.''\56\ This deluge of
debt collection suits means the following abusive debt
collection practices can occur: filing collection suits against
the wrong people; filing suits past the statute of limitations;
collection attorneys not having any proof of the debt sued upon
and falsely swearing they do; suing for more than is legally
owed; and laundering a time-barred debt with a new judgment.
Most of these cases result in default judgment, often with
little or no evidence to support the debt, because the debtor
is intimidated and does not show up. Once a creditor obtains a
judgment, the effects can be sustained and devastating,
regardless of whether the consumer actually owed on the
underlying debt. Despite the FDCPA, the FTC in February of 2009
issued a report stating that debt collection litigation
practices appear to raise substantial consumer protection
concerns.
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\55\``Debtors' Hell'' 4-Part Series, Boston Globe, July 30-August
2, 2006.
\56\``Collecting Consumer Debts: The Challenges Of Change,''
Federal Trade Commission, February 2009, p. 55.
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Payday Lending. Payday loans are small, short-term cash
advances made at extremely high interest rates. Typically, a
borrower writes a personal check for $100-$500, plus a fee,
payable to the lender. The loan is secured by the borrower's
personal check or some form of electronic access to the
borrower's bank account, and the full amount of the loan plus
interest must be repaid on the borrower's next payday to keep
the personal check required to secure the loan from bouncing.
The average loan amount for a payday loan is $325, and
finance charges are generally calculated as a fee per hundred
dollars borrowed. This fee is usually $15 to $30 per $100
borrowed. The average interest rate for a payday loan is
between 391% and 782% APR for a two-week loan. Payday loans
cost consumers over $4.2 billion in fees each year.
Cash-strapped consumers who must borrow money this way are
usually in significant debt or living on the financial edge. A
loan can become even more expensive for the borrower who does
not have the funds to repay the loan at the end of two weeks
and obtains a rollover or loan extension. Many borrowers must
devote 25 to 50 percent of their take-home income to repay the
payday loan, leaving them with inadequate resources to meet
their other obligations. This often leads to a succession of
new payday loans for that family.\57\ An additional fee is
attached each time the loan is extended through a rollover
transaction. The high rates make it difficult for many
borrowers to repay the loan, thus putting many consumers on a
perpetual debt treadmill where they extend the loan several
times over. For example, if a payday loan of $100 for 14 days
with a fee of $15 were rolled over three times, it would cost
the borrower $60 to borrow $100 for 56 days. Loan fees can
quickly mount and could eventually become greater than the
amount actually borrowed. The typical payday borrower renews
his or her loan multiple times before being able to pay the
loan in full, and ends up paying $793 for a $325 loan.\58\
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\57\Leslie Parish and Uriah King, Phantom Demand, Center for
Responsible Lending, July 9, 2009.
\58\King, Uriah, Parrish, Leslie, and Tanki, Ozlem. ``Financial
Quicksand.'' Center for Responsible Lending. November 30, 2006.
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If the borrower defaults on the loan, serious financial
consequences can occur. Loans secured by personal checks or
electronic access to the borrower's bank account can endanger
the banking status of borrowers. The lender can deposit the
customer's personal check, which would result in additional
fees from the bank for insufficient funds if it did not clear
the borrower's checking account and could result in the
consumer being identified as a writer of bad checks. Requiring
consumers to turn over a post-dated check can subject consumers
to coercion or harassment by illegal threats or coercive
collection practices. For example, consumers have reported
being threatened with jail for passing a bad check, even when
the law specifically says they cannot be prosecuted if the
check bounces.
Auto Dealer Lending. Auto loans constitute the largest
category of consumer credit outside of mortgages. Today, there
is more outstanding auto debt ($850 billion) than there is
credit card debt in this country. Auto dealers finance 79% of
the purchases of cars in the United States. Auto dealers
actively market and price borrowers' loans. They also routinely
mark up loan rates that are higher than the borrower would need
to pay to qualify for the credit, and, like mortgage brokers or
bankers, the auto dealers collect a significant portion of the
excess finance charges that result from that markup, similar to
a yield spread premium.\59\ In addition, auto dealers often
charge origination fees and may use the financing transaction
as a way to sell other unrelated products (warranties and
credit insurance, for example) to unsuspecting buyers. Unlike a
mortgage broker, however, auto dealers are the legal creditors.
---------------------------------------------------------------------------
\59\Raj Date and Brian Reed, Auto Race to the Bottom; Free Markets
and Consumer Protection in Auto Finance, November 16, 2009.
---------------------------------------------------------------------------
As with mortgages, borrowers are simply unaware of the
incentives pushing the auto dealers to charge buyers higher
interest rates. Auto dealers have a history of abusive and
discriminatory lending. In a letter to Chairman Dodd and
Ranking Member Shelby, the Leadership Conference on Civil
Rights (LCCR) explains that:
detailed research by academics earlier this decade on
millions of auto loans revealed that auto dealers were
far more likely to mark up the loan rates of
minorities. Class actions revealed discrimination at
GM, Toyota, Ford dealerships, among others. As a
result, courts ordered most major car finance companies
to cap rates . . . though the orders expire soon.\60\
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\60\Letter to Chairman Dodd and Ranking Member Shelby from the
Leadership Conference on Civil Rights, December 3, 2009. The letter
explains that ``minority car buyers pay significantly higher dealer
markups [for auto loans] than non-minority car buyers with the same
credit scores.'' (Emphasis in original).
In meetings with Banking Committee staff, the National
Automobile Dealers Association (NADA) argued that the current
rate cap imposed by the courts mitigate the need for CFPB
rulemaking to protect consumers. To the contrary, this history
of discriminatin indicates the need for careful oversight into
the future, particularly as the court orders expire over the
next several years.
As with mortgage bankers and brokers, auto dealers use an
``originate to sell'' model which results in the car dealers
receiving upfront compensation for originating the loans,
without regard to the ongoing performance of the loan. And,
unlike mortgages, very few people ever refinance car loans,
even if they find out that they have been charged above-market
rates. As a result, auto dealers have a significant incentive
to steer borrowers to the highest rate loans they can, without
borrowers ever being aware of the backdoor transaction.
In addition to minorities and lower-income borrowers,
military personnel are among those whom are frequently
exploited by auto dealers. For that reason, Clifford Stanley,
the Under Secretary of Defense for Personnel and Readiness,
``welcome[s] and encourage[s] CFP[B] protections'' for service
members and their families ``with regard to unscrupulous
automobile sales and financing practices. . ..'' Under
Secretary Stanley writes that the oversight of auto financing
by the CFPB for service members will help reduce concerns they
have about their well-being. He goes on to say:
The Department of Defense fully believes that
personal financial readiness of our troops and families
equates to mission readiness.\61\
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\61\Letter from Under Secretary of Defense to Clifford Stanley to
Assistant Secretary of the Treasury, Michael Barr. February 26, 2010.
Similarly, The Military Coalition, a consortium of
nationally prominent military and veterans organizations
representing more than 5.5 million current and former service
members and their families supports CFPB regulation of auto
dealers with regard to auto lending. In a letter to the
Chairman and Ranking Member, the Coalition notes that auto
financing is ``the most significant financial obligation for
the majority of service members.'' It goes on to say that
``including auto dealers financing . . . in the financial
reform bill will provide greater protections for our service
members and their families'' by protecting them from reported
abuses such as bait and switch financing, falsification of loan
documents, failure to pay off liens, and packing loans with
other products.\62\
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\62\Letter to Chairman Dodd and Ranking Member Shelby from The
Military Coalition, April 15, 2010. The Coalition includes 31 members,
including the Veterans of Foreign Wars, the Military Order of the
Purple Heart, the National Guard Association of the U.S., the Non
Commissioned Officers Association of the U.S.A., the Iraq and
Afghanistan Veterans of America, and others.
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Access to automobile financing on fair terms is very
important to American families, particularly to low-income
families. Studies indicate that access to a reliable automobile
is an important factor for finding and keeping jobs, especially
as more and more jobs are being created outside of city
centers. Writing in New England Community Developments, Signe-
Mary McKernan and Caroline Ratcliffe of the Urban Institute
note that:
providing low-income families with less burdensome
auto-financing alternatives and helping them avoid the
subprime loan market can lead to better credit scores
and increase the likelihood that low-income families
become integrated into the formal financial sector.\63\
---------------------------------------------------------------------------
\63\Signe-Mary McKernan and Caroline Ratcliffe, ``Asset Building
for Today's Stability and Tomorrow's Security,'' New England Community
Developments, Federal Reserve Bank of Boston, 2009, Issue 2.
However, despite the abuses in this sector, and the urgent
need for better consumer protections, the federal government
has not done enough to address these issues. ``Given the
widespread nature of the problem [with auto lending] revealed
in the academic studies and private litigation, the current
structure has failed to effectively police auto finance.''\64\
That is one of the reasons, according to the LCCR, the CFPB is
needed.
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\64\Letter to Chairman Dodd and Senator Shelby by the LCCR,
December 3, 2009.
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STRENGTHENING AND CONSOLIDATING PRUDENTIAL SUPERVISION
Title III seeks to increase the accountability of the
banking regulators by establishing clearer lines of
responsibility and to reduce the regulatory arbitrage in the
financial regulatory system whereby financial companies
``shop'' for the most lenient regulators and regulatory
framework. ``One clear lesson learned from the recent crisis
was that competition among different government agencies
responsible for regulating similar financial firms led to
reduced regulation in important parts of the financial system.
The presence of multiple federal supervisors of firms that
could easily change their charter led to weaker regulation and
became a serious structural problem within our supervisory
system.''\65\
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\65\``Financial Regulatory Reform: A New Foundation'',
Administration's White Paper, June 2009.
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Need to Consolidate Fragmented Banking Supervision
Title III rationalizes the fragmented structure of banking
supervision in the U.S. by abolishing one of the multiple
banking regulators, consolidating supervision of state banks in
a single federal regulator, and consolidating supervision of
smaller bank holding companies (those with assets of less than
$50 billion) so that the regulator for the bank or thrift will
also regulate the holding company. For the largest bank and
thrift holding companies, the Board will be the consolidated
holding company supervisor. The Board will thus focus its
supervisory responsibilities on the larger, more interconnected
bank and thrift holding companies (which will include, but not
be limited to, those companies whose failures potentially pose
risk to U.S. financial stability) where its experience in
capital and global markets can best be applied. By
consolidating its supervision over these holding companies, the
Board can pursue risks wherever they may emerge within the
company (including its subsidiaries) and will ultimately be
responsible for the sound operation of the entire organization.
The Committee heard repeated testimony that the U.S.
financial regulatory system is more a product of history and
responses to various crises, than deliberate design. According
to the GAO, it has not kept pace with major developments in the
financial marketplace. In testimony before the Committee on
September 29, 2009, the GAO testified in favor of decreasing
fragmentation in the system (beyond the Administration's
proposal to abolish the OTS), reducing the potential for
differing regulatory treatment, and improving regulatory
independence.\66\
---------------------------------------------------------------------------
\66\Testimony of Richard J. Hillman, Managing Director Financial
Markets and Community Investment, GAO, to the Banking Committee, 9/29/
09.
---------------------------------------------------------------------------
At the same hearing, former Comptroller of the Currency,
Eugene Ludwig, testified that, ``We must dramatically
streamline the current alphabet soup of regulators'', citing
the needless burden on financial institutions of the
duplicative and inefficient system, the fertile ground that
multiple regulatory agencies create for regulatory arbitrage,
and the serious gaps between regulatory responsibilities.\67\
---------------------------------------------------------------------------
\67\Testimony of Eugene Ludwig to the Banking Committee, 9/29/09.
---------------------------------------------------------------------------
The Committee heard testimony from Richard Carnell, Fordham
Law School professor and former Treasury Assistant Secretary
for Financial Institutions, that our current bank regulatory
structure is needlessly complex and costly for banks. He
maintained that its overlapping jurisdictions and
responsibilities undercut regulators' accountability. And, it
encourages regulators to compete with each other for
``regulatory clientele'' thereby creating an incentive for
laxity in supervision.\68\
---------------------------------------------------------------------------
\68\Testimony of Richard Carnell to the Banking Committee,
September 29, 2009.
---------------------------------------------------------------------------
These sentiments were echoed by Martin Baily, senior fellow
with the Brookings Institution, and former Chairman of the
Council of Economic Advisers, who testified about the need for
increased accountability among regulators. In speaking about
competition among regulators Baily said, ``The serious danger
in regulatory competition is that it allows a race to the
bottom as financial institutions seek out the most lenient
regulator that will let them do the risky things they want to
try, betting with other people's money.''\69\
---------------------------------------------------------------------------
\69\Testimony of Martin Baily to the Banking Committee, September
29, 2009.
---------------------------------------------------------------------------
The Committee also heard testimony that the number of
banking regulators could be reduced by creating a single
federal regulator for state chartered banks, in contrast to the
current scheme in which the Federal Reserve and the FDIC each
supervise certain state banks. According to Comptroller of the
Currency, John Dugan, ``Today there is virtually no difference
in the regulation applicable to state banks at the federal
level based on membership in the [Federal Reserve] System and
thus no real reason to have two different federal regulators.
It would be simpler to have one. Opportunities for regulatory
arbitrage--resulting, for example, from differences in the way
federal activities restrictions are administered by one or the
other regulator--would be reduced. Policy would be
streamlined.'' Dugan went on to state the importance of
ensuring the FDIC maintain a window into day-to-day banking
supervision, which would be less of a problem for the Board if
it maintained holding company supervision.\70\
---------------------------------------------------------------------------
\70\Testimony of John Dugan to the Banking Committee, August 4,
2009.
---------------------------------------------------------------------------
Dugan identified further opportunity for regulatory
consolidation. He testified there was little need for separate
holding company regulation where the bank is small or where it
is the holding company's only, or dominant, asset.
``Elimination of a separate holding company regulator thus
would eliminate duplication, promote simplicity and
accountability, and reduce unnecessary compliance burden for
institutions as well. The case is harder and more challenging
for the very largest bank holding companies engaged in complex
capital market activities, especially where the company is
engaged in many, or predominantly, nonbanking activities, such
as securities and insurance.'' In those cases, Dugan
recommended maintaining the role of the Board as the holding
company supervisor.\71\
---------------------------------------------------------------------------
\71\Id.
---------------------------------------------------------------------------
In his September 2009 testimony, Baily echoed Dugan's
remarks that there was no good case for the Board to continue
to supervise smaller bank holding companies. That regulation
should be moved to the prudential regulator. Indeed public data
from the banking regulators from year end 2009 demonstrate that
in almost all instances of banking organizations with less than
$50 billion in assets, the vast majority of assets are in the
depository institution. According to Federal Reserve Board
Governor Daniel Tarullo, ``When a bank holding company is
essentially a shell, with negligible activities or ownership
stakes outside the bank itself, holding company regulation can
be less intensive and more modest in scope.''\72\
---------------------------------------------------------------------------
\72\Testimony of Daniel Tarullo to the Banking Committee, August 4,
2009.
---------------------------------------------------------------------------
Title III adopts a number of these recommendations for
consolidating bank supervision to enhance the accountability of
individual regulators, reduce the opportunities for depository
institutions to shop for the most lenient regulator, reduce
regulatory gaps in supervision, and limit inefficiencies,
duplication and needless regulatory burdens on the industry.
Title III does so by abolishing the OTS in accordance with the
Administration's financial reform proposal.
Abolishing the OTS
The OTS is responsible for regulating state and federal
thrifts, as well as their holding companies.\73\ The thrift
charter suffered disproportionate losses during the financial
crisis. According to FDIC data, 95 percent of failed
institution assets in 2008 were attributable to thrifts
regulated by the OTS. These losses were predominantly
attributed to the failures of Washington Mutual and Indy Mac
Bank.\74\ From the start of 2008 through the present, 73
percent of failed institution assets were attributable to
thrifts regulated by the OTS, even though the agency supervised
only 12 percent of all bank and thrift assets at the beginning
of this period.
---------------------------------------------------------------------------
\73\The OTS currently regulates 694 federal thrifts and 63 state
thrifts.
\74\In its reports of the Washington Mutual and IndyMac failures,
the inspectors general offices of the Treasury and FDIC cited numerous
shortcomings with OTS supervision. With over $300 billion in total
assets, Washington Mutual was OTS's largest regulated institution and
represented as much as 15 percent of OTS's total assessment revenue
from 2003 to 2008. The inspectors general found that, despite the
multiple findings by OTS examiners of weaknesses at Washington Mutual,
the OTS consistently gave the bank a high composite rating (CAMELS--
capital, assets, management, earnings, liquidity, and sensitivity to
risk) and Washington Mutual was thus considered well-capitalized until
its closure. They further concluded that OTS did not adequately ensure
that the thrift's management corrected examiner-identified weaknesses,
that the agency failed to take formal enforcement action until it was
too late, and that the OTS never instituted corrective measures under
``prompt corrective action'' (PCA) to minimize losses to the Deposit
Insurance Fund because the OTS never properly downgraded the bank's
CAMELS rating that would have triggered PCA. Evaluation of Federal
Regulatory Oversight of Washington Mutual Bank, Report No. EVAL-10-002,
April 2010.
In the case of IndyMac, the Treasury Inspector General found that
the OTS did not identify or sufficiently address the core weaknesses
that ultimately caused the thrift to fail until it was too late. As in
the case of Washington Mutual, the Inspector General found that the OTS
gave IndyMac inflated CAMELS ratings, and, that it failed to follow up
with bank management to ensure that corrective actions were taken. The
Inspector General also found that the OTS waited too long to bring an
enforcement action against the bank. Material Loss Review of IndyMac
Bank, FSB (OIG-09-032).
---------------------------------------------------------------------------
In its White Paper on reforming the financial regulatory
system, the Administration argues that advances in the
financial services industry have decreased the need for federal
thrifts as a specialized class of depository institutions
focused on mortgage lending.\75\ Additionally, the White Paper
points out that the thrift charter ``created opportunities for
private sector arbitrage'' of the regulatory system and that
its focus on residential mortgage lending made it particularly
susceptible to the housing downturn.\76\ The fragility of the
charter is borne out by the statistics, including the fact that
total assets of OTS-supervised thrifts declined by 36 percent
between 2006 and 2009, compared to an increase of 11 percent in
all FDIC-insured banks and thrifts for the same time period.
---------------------------------------------------------------------------
\75\``Financial Regulatory Reform: A New Foundation'', June 2009.
\76\Id. The OTS was also the consolidated supervisor of AIG because
AIG was a thrift holding company. To date, AIG's failure has cost the
U.S.government over $180 billion.
---------------------------------------------------------------------------
Thus the bill does not permit the chartering of any new
federal thrifts and disbands the OTS. Title III apportions the
responsibility to regulate thrifts and thrift holding companies
among the FDIC, the OCC and the Federal Reserve, and ensures
that all OTS employees are transferred to the FDIC and the OCC.
Consolidating Federal Supervision of State Banks and Smaller Bank
Holding Companies
It also consolidates federal supervision for state banks in
the FDIC. As of yearend 2009, the FDIC regulated 4,941 state
banks ranging in size from less than one billion dollars in
assets to more than $100 billion in assets, compared to the 844
banks the Federal Reserve supervised. In addition to the state
banks the FDIC supervises, the agency has on-site dedicated
examiners at the largest banks. The FDIC also conducts targeted
supervisory activities at specific Federal Reserve regulated
banks over $10 billion. These institutions present complex risk
profiles and activities and operations that include
international operations, securitization activities, and
trading books with material derivatives exposures. Thus, the
FDIC has ample experience in supervising banks of all sizes,
including large, complex organizations.
And Title III gives the prudential regulators--the FDIC and
the OCC--the responsibility for supervising the holding
companies of smaller, less complex organizations where nearly
all of the assets in the holding companies are concentrated in
the depository institutions these agencies already regulate.
The Board, however, will retain its supervisory responsibility
for the larger bank holding companies and for the larger thrift
holding companies, thus ensuring that the Board continues to
have a window into day-to-day supervision.
Focusing the Federal Reserve System on its Core Functions
The crisis exposed the shortcomings of the Federal Reserve
System--mainly that it has too many responsibilities to execute
well.\77\\78\ Currently, the Federal Reserve is responsible for
conducting monetary policy, policing the payment system,
serving as the lender of last resort, supervising state member
banks, regulating all bank holding companies, and writing most
of the consumer financial protection rules.
---------------------------------------------------------------------------
\77\The Committee heard testimony about the failures of the Federal
Reserve in executing its consumer protection functions, as well as in
identifying the risks in bank holding companies. Martin Eakes, CEO of
Self-Help and CEO of the Center for Responsible Lending, testified to
the Committee in November 2008, ``The Board has been derelict in the
duty to address predatory lending practices. In spite of the rampant
abuses in the subprime market and all the damage imposed on consumers
by predatory lending--billions of dollars in lost wealth--the Board has
never implemented a single discretionary rule under HOEPA outside of
the high cost context. To put it bluntly, the Board has simply not done
its job.''
\78\Speaking to its failures in identifying risk, Orice Williams,
Director of Financial Markets and Community Investment at the
Government Accountability Office, testified to the Committee in March
2009, ``Although for some period, the Federal Reserve analyzed
financial stability issues for systemically important institutions it
supervises, it did not assess the risks on an integrated basis or
identify many of the issues that just a few months later led to the
near failure of some of these institutions and to severe instability in
the overall financial system.''
---------------------------------------------------------------------------
Chairman Dodd and other members of the Committee repeatedly
expressed concerns during hearings about the many
responsibilities of the Federal Reserve and about the need to
preserve the Federal Reserve's primary focus on its core
function of monetary policy. The Chairman also expressed
concerns that so many diverse functions could ultimately
threaten the independence of the Federal Reserve's monetary
policy. Chairman Dodd said, ``Some have expressed a concern--
which I share, by the way--about overextending the Fed when
they have not properly managed their existing authority,
particularly in the area of protecting consumers.''\79\ The
Chairman also said, ``I worry that over the years loading up
the Federal Reserve with too many piecemeal responsibilities
has left important duties without proper attention and exposed
the Fed to dangerous politicization that threatens the very
independence of this institution.''\80\ Ranking Member Shelby
stated, ``The Federal Reserve already handled monetary policy,
bank regulation, holding company regulation, payment systems
oversight, international banking regulation, consumer
protection, and the lender-of-last-resort function. These
responsibilities conflict at times, and some receive more
attention than others. I do not believe that we can reasonably
expect the Fed or any other agency [to] effectively play so
many roles.''\81\
---------------------------------------------------------------------------
\79\Statement of Chairman Chris Dodd, hearing of the Banking
Committee, 12/3/09.
\80\Statement of Chairman Chris Dodd, hearing of the Banking
Committee, 2/4/09.
\81\Ranking Member Richard Shelby, Banking Committee hearing, 6/18/
09.
---------------------------------------------------------------------------
In response to a question from Ranking Member Shelby,
Former Federal Reserve Chairman Paul Volcker agreed that the
Federal Reserve's conduct of monetary policy could be
undermined if the Fed assumed additional responsibilities.\82\
Chairman Volcker further testified, ``You will have a different
Federal Reserve if the Federal Reserve is going to do the main
regulation or all the regulation from a prudential standpoint.
And you'll have to consider whether that's a wise thing to do,
given their primary--what's considered now their primary
responsibilities for monetary policy. They obviously have
important regulatory functions now, and maybe those functions
have not been pursued with sufficient avidity all the time. But
if you're going to give them the whole responsibility, for
which there are arguments, I do think you have to consider
whether that's consistent with the degree of independence that
they have to focus on monetary policy.''\83\
---------------------------------------------------------------------------
\82\Banking Committee hearing, ``Modernizing The U.S. Financial
Regulatory System,'' 2/4/09.
\83\Testimony of Former Federal Reserve Board Chairman Paul Volcker
to the Banking Committee, February 9, 2009.
---------------------------------------------------------------------------
To narrow the focus of the Federal Reserve to its core
functions, the bill strips it of its consumer protection
functions,\84\ and its role in supervising a relatively small
number of state banks, as well as smaller bank holding
companies. However, the Committee was persuaded that because of
the Federal Reserve's expertise and its other unique functions,
it should play an expanded role in maintaining financial
stability.\85\ Thus, Title III assigns the Federal Reserve the
responsibility for the supervision of bank and thrift holding
companies with assets over $50 billion. (Other aspects of the
bill that address financial stability enhance the Federal
Reserve's oversight of systemically important payment systems,
direct the Federal Reserve to apply heightened prudential
standards to large bank holding companies, and give the Federal
Reserve supervisory responsibilities over designated nonbank
financial companies.) To ensure the Federal Reserve can focus
on these and its other essential responsibilities, the bill
assigns the regulation of state member banks and smaller bank
holding companies to other federal regulators. The bill
therefore strikes an important balance in providing the Federal
Reserve with enhanced authority to maintain financial
stability, while at the same time, reducing its
responsibilities for areas that are not central to its mission.
---------------------------------------------------------------------------
\84\In proposing to take away the Federal Reserve's authority to
write and enforce consumer protection rules Secretary Geithner called
this authority a ``preoccupation and distraction'' for the Federal
Reserve in testimony to the Banking Committee, June 18, 2009.
Martin Baily, Senior Fellow of Economic Studies at the Brookings
Institution, stated in testimony during a hearing in September 2009
that the Federal Reserve Board's added focus on consumer protection
took time from properly doing the rest of its job: ``I think the thing
that the Federal Reserve has done well is monetary policy . . . they
certainly haven't done a great job on prudential regulation and I don't
see--what is the point of the Chairman of the Federal Reserve sitting
around worrying about details of credit card regulation? That is what
he is doing right now, and I think that is a mistake and not a good use
of his time.''
\85\``The Fed has several missions, and monetary policy is the
primary one,'' said Alice Rivlin, a Brookings Institution scholar and
former Fed vice chairman. ``But they also have a mission to stabilize
the banking system, and we're in the process of expanding our view of
what the banking system is.'' Washington Post, 7/17/08.
---------------------------------------------------------------------------
Finally, it should be noted that Title III leaves intact
the Federal Reserve's ability to obtain information needed for
the conduct of monetary policy. Section 11 of the Federal
Reserve Act gives the Board of Governors authority to require
any depository institution to provide ``such reports of its
liabilities and assets as the Board may determine to be
necessary or desirable to enable the Board to discharge its
responsibility to monitor and control monetary and credit
aggregates.'' This information may be obtained from any bank,
savings and loan association, or credit union, and does not
depend on the chartering agency or regulator of the depository.
In addition, section 21 of the Federal Reserve Act provides
that the Board may conduct special examinations of any Federal
Reserve member bank. Members include all national banks and
state banks that elect to become members of their district
Federal Reserve bank. These provisions of the Federal Reserve
Act remain unchanged. Therefore the Federal Reserve will retain
extensive powers to gather the data it needs to conduct
monetary policy, including data from banks that it does not
supervise.
REGULATION OF OVER-THE-COUNTER DERIVATIVES AND SYSTEMICALLY SIGNIFICANT
PAYMENT, CLEARING, AND SETTLEMENT FUNCTIONS
Making derivatives safer is a very important part of
solving too-big-to-fail.\86\--Chairman Ben Bernanke
---------------------------------------------------------------------------
\86\Testimony of Ben Bernanke, Federal Reserve Board Chairman, to
the Senate Banking Committee, 12/3/09.
Many factors led to the unraveling of this country's
financial sector and the government intervention to correct it,
but a major contributor to the financial crisis was the
unregulated over-the-counter (``OTC'') derivatives market.
Derivatives can trade either over-the-counter where contracts
are often customized and privately negotiated between
counterparties, or through regulated central clearinghouses and
exchanges that establish rules for trading contracts among many
different counterparties.
Massive growth in bilateral, unregulated derivatives
trading: At the time of the crisis in December, 2008, the
global over-the-counter derivatives market stood at $592
trillion.\87\ The top five derivatives dealers in the United
States accounted for 96 percent of outstanding over-the-counter
contracts made by the leading bank holding companies, according
to the OCC. As such, this market was dominated by the too-big-
to-fail financial companies that trade derivatives with
financial and non-financial users. The dangers posed by the OTC
derivatives market have been known for many years. In 1994, the
GAO produced a report, titled, ``Financial Derivatives: Actions
Needed to Protect the Financial System.'' At the time of their
report, the GAO determined the size of the derivatives market
to be $12.1 trillion. Included in GAO's findings in 1994 were
concerns about risks to taxpayers arising from the
interconnectedness between dealers and end users: ``the rapid
growth and increasing complexity of derivatives activities
increase risks to the financial system, participants, and U.S.
taxpayers;'' and ``relationships between the 15 major U.S.
dealers that handle most derivatives activities, end users, and
the exchange-traded markets makes the failure of any one of
them potentially damaging to the entire financial market.''\88\
By the time of the 2008 crisis, the derivatives market had
grown to be almost fifty times as large from when GAO raised a
red flag. Much of this growth has been attributed to the
Commodities Futures Modernization Act of 2000 which explicitly
exempted OTC derivatives, to a large extent, from regulation by
the Commodity Futures Trading Commission (``CFTC'') and limited
the SEC's authority to regulate certain types of OTC
derivatives. By 2008, 59 percent of derivatives were traded
over-the-counter, or away from regulated exchanges, compared to
41 percent in 1998.
---------------------------------------------------------------------------
\87\Bank for International Settlements, press release, 5/19/09.
\88\U.S. Government Accountability Office, ``Financial Derivatives:
Actions Needed to Protect the Financial System,'' GGD-94-133 May 18,
1994.
---------------------------------------------------------------------------
According to the Obama Administration, ``the downside of
this lax regulatory regime . . . became disastrously clear
during the recent financial crisis . . . many institutions and
investors had substantial positions in credit default swaps--
particularly tied to asset backed securities . . . excessive
risk taking by AIG and certain monoline insurance companies
that provided protection against declines in the value of such
asset backed securities, as well as poor counterparty credit
risk management by many banks, saddled our financial system
with an enormous--and largely unrecognized--level of risk.''
``[T]he sheer volume of these contracts overwhelmed some firms
that had promised to provide payment on the CDS and left
institutions with losses that they believed they had been
protected against. Lacking authority to regulate the OTC
derivatives market, regulators were unable to identify or
mitigate the enormous systemic threat that had developed.''\89\
---------------------------------------------------------------------------
\89\Obama Administration white paper, Financial Regulatory Reform:
A New Foundation, June 2009.
---------------------------------------------------------------------------
OTC contracts can be more flexible than standardized
contracts, but they suffer from greater counterparty and
operational risks and less transparency. Information on prices
and quantities is opaque. This can lead to inefficient pricing
and risk assessment for derivatives users and leave regulators
ill-informed about risks building up throughout the financial
system. Lack of transparency in the massive OTC market
intensified systemic fears during the crisis about interrelated
derivatives exposures from counterparty risk. These
counterparty risk concerns played an important role in freezing
up credit markets around the failures of Bear Stearns, AIG, and
Lehman Brothers.
Hidden leverage due to under-collateralization: Although
over-the-counter derivatives can be used to manage risk and
increase liquidity, they also increase leverage in the
financial system; traders can take large speculative positions
on a relatively small capital base because there are no
regulatory requirements for margin or capital. The ability of
derivatives to hide leverage was evident in problems faced by
financial companies such as Bear Stearns and Lehman as well as
non-financial derivatives participants such as the government
of Greece--Chairman Gensler recently stated that higher capital
requirements for derivatives would have prevented Greece from
using currency swaps to hide debt.\90\ When users negotiate
margin bilaterally, they ``will act in their own interest to
manage their risk. These actions may not take into account the
spillover risk throughout the system.''\91\ For example, the
markets generally considered AIG Financial Products (``AIGFP'')
an extremely low risk counterparty because its parent company
was rated AAA. This high rating allowed AIGFP to hold lower
capital/margin against its derivatives portfolio. Had market
participants or regulators demanded more capital, the company
would have had less incentive to enter into such large
positions as the projected return on investment would have been
lower. Even if AIGFP had such large positions, the company
would have had more funds to apply to the losses. Had
information been more readily available to regulators and
counterparties about the scope of AIGFP's credit default swap
positions, regulators and market participants might have
detected the systemic implications of AIGFP's book.
---------------------------------------------------------------------------
\90\Associated Press, U.S. Warns EU Derivatives Ban Won't Work, 3/
16/10.
\91\Acharya, et al., The Ultimate Financial Innovation, 2008.
---------------------------------------------------------------------------
The dangers of under-collateralization were recently
identified by the International Monetary Fund (``IMF'') and the
Wall Street Journal:
The main risk posed by this gigantic pool is the
hidden leverage. Put simply, a bank may have a large
derivatives position but avoid posting cash upfront
with its trading partner as others do.
This ``under-collateralization'' makes the system
prone to runs because, when instability arrives, all
banks rush to collect what they are owed on
derivatives--and try to delay paying out what they
themselves owe. Witness the Lehman Brothers collapse.
And the numbers aren't small.
On Tuesday, the International Monetary Fund released
a paper estimating that five large U.S. derivatives
dealers were potentially under-collateralized by
between $500 billion and $275 billion as of September
2009. The IMF gets to that range using firms' net
derivatives liabilities, a figure showing how much
banks owe on derivatives trades adjusted for netting
and collateral posting.
Putting nearly all derivatives through
clearinghouses, with tough margin rules, could do away
with most of the under-collateralization. The IMF says
getting there could be very costly for the banks. But
consider it a bill they should have paid years ago.\92\
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\92\Wall Street Journal, 4/13/10.
Counterparty credit exposure in the derivatives market was
largely seen as a source of systemic risk during the failures
of both Bear Stearns and Lehman Brothers, and would have
brought down AIG but for a massive collateral payment made with
taxpayer money. It created the dangerous interconnections that
spread and amplified risk across the entire financial system.
More collateral in the system, through margin requirements,
will help protect taxpayers and the economy from bailing out
companies' risky derivatives positions in the future. In
testimony before the Senate Banking Committee, Federal Reserve
Chairman Bernanke described margin requirements for derivatives
users as ``an appropriate cost of protecting against
counterparty risk.''\93\
---------------------------------------------------------------------------
\93\Chairman Bernanke, Senate Banking Committee testimony, 12/3/09.
---------------------------------------------------------------------------
Need to reduce systemic risk build-up and risk transmission
in the derivatives market: Chairman Gensler of the Commodity
Futures Trading Commission described the flaws of bilaterally-
negotiated margin as follows: ``Even though individual
transactions with a financial counterparty may seem
insignificant, in aggregate, they can affect the health of the
entire system.''\94\ ``One of the lessons that emerged from
this recent crisis was that institutions were not just `too big
to fail,' but rather too interconnected as well. By mandating
the use of central clearinghouses, institutions would become
much less interconnected, mitigating risk and increasing
transparency. Throughout this entire financial crisis, trades
that were carried out through regulated exchanges and
clearinghouses continued to be cleared and settled.''\95\
---------------------------------------------------------------------------
\94\Chairman Gensler, Senate Agriculture Committee testimony, 11/
18/09.
\95\Chairman Gensler, Senate Banking Committee testimony, 6/22/09.
---------------------------------------------------------------------------
In July of 2008, during a hearing on derivatives regulation
before the Senate Banking Committee, Patrick Parkinson, deputy
director of the Division of Research and Statistics for the
Board of Governors of the Federal Reserve System, testified to
the danger present in the OTC derivatives market: ``weaknesses
in the infrastructure for the credit derivatives markets and
other OTC derivatives markets have created operational risks
that could undermine the effectiveness of counterparty risk-
management practices.''\96\ In June of 2009, A. Patricia White,
the associate director of the Division of Research and
Statistics for the Board of Governors of the Federal Reserve
System, testified about unregulated derivatives' ability to
spread harm through the system and the need to combat such
risk. Ms. White said, ``OTC derivatives appear to have
amplified or transmitted shocks. An important objective of
regulatory initiatives related to OTC derivatives is to ensure
that improvements to the infrastructure supporting these
products reduce the likelihood of such transmissions and make
the financial system as a whole more resilient to future
shocks. Centralized clearing of standardized OTC products is a
key component of efforts to mitigate such systemic risk.''\97\
While the systemic risk presented by the unregulated OTC
derivatives market has long been known, it was realized in 2008
with devastating consequences. Now it must be addressed to
restore stability and confidence in the financial system.
---------------------------------------------------------------------------
\96\Testimony before the Subcommittee on Securities, Insurance, and
Investment of the Senate Committee on Banking, Housing, and Urban
Affairs, 7/9/08.
\97\Testimony before the Subcommittee on Securities, Insurance, and
Investment of the Senate Committee on Banking, Housing, and Urban
Affairs, 6/22/09.
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Creating a Safer Derivatives Market to Protect Taxpayers Against Future
Bailouts
As a key element of reducing systemic risk and protecting
taxpayers in the future, protections must include comprehensive
regulation and rules for how the OTC derivatives market
operates. Increasing the use of central clearinghouses,
exchanges, appropriate margining, capital requirements, and
reporting will provide safeguards for American taxpayers and
the financial system as a whole.
Under Title VII, for the first time, over-the-counter
derivatives will be regulated by the SEC and the CFTC, more
transactions will be required to clear through central clearing
houses and trade on exchanges, un-cleared swaps will be subject
to margin requirements, swap dealers and major swap
participants will be subject to capital requirements, and all
trades will be reported so that regulators can monitor risks in
this vast, complex market. Under Title VIII, the Federal
Reserve will be granted the authority to regulate and examine
systemically important payment, clearing, and settlement
functions. The overall result would be reduced costs and risks
to taxpayers, end users, and the system as a whole. The
language in these titles is based on proposals drafted by the
Obama Administration and includes all of the key regulatory
features for derivatives market reform that have been endorsed
by the G20: more central clearing, exchange trading, capital,
margin, and transparency.
G20 Steering Group Letter, 3/31/10: ``Standardized
over-the-counter derivatives contracts should be traded
on exchanges or electronic platforms, where
appropriate, cleared through central clearing
counterparties by 2012 at the latest, and reported to
trade repositories.''\98\
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\98\G20 Steering Group Letter, 3/31/10.
G20 Leaders' Statement, The Pittsburgh Summit, 9/25/09:
``Improving over-the-counter derivatives markets: All
standardized OTC derivative contracts should be traded
on exchanges or electronic trading platforms, where
appropriate, and cleared through central counterparties
by end-2012 at the latest. OTC derivative contracts
should be reported to trade repositories. Non-centrally
cleared contracts should be subject to higher capital
requirements. We ask the FSB and its relevant members
to assess regularly implementation and whether it is
sufficient to improve transparency in the derivatives
markets, mitigate systemic risk, and protect against
market abuse.''\99\
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\99\G20 Leaders' Statement, The Pittsburgh Summit, 9/25/09, http://
www.pittsburghsummit.gov/mediacenter/129639.htm.
The combination of these new regulatory tools will provide
market participants and investors with more confidence during
times of crisis, taxpayers with protection against the need to
pay for mistakes made by companies, derivatives users with more
price transparency and liquidity, and regulators with more
information about the risks in the system.
Central clearing, margin, and capital requirements as a
systemic risk management tool: ``The main tool for regulating
contagion and systemic risk is liquidity reserves
(margin).''\100\ In the OTC market, margin requirements are set
bilaterally and do not take account of the counterparty risk
that each trade imposes on the rest of the system, thereby
allowing systemically important exposures to build up without
sufficient capital to mitigate associated risks. The problem of
under-collateralization is especially apparent in bank
transactions with non-financial firms and regulators should
address this problem through the new margin requirements for
uncleared derivatives established in the legislation. According
to the Comptroller of the Currency, ``Banks held collateral
against 64 percent of total net current credit exposure
(``NCCE'') at the end of the third quarter. Bank credit
exposures to banks/securities firms and hedge funds are very
well secured. Banks hold collateral against 90 percent of their
exposure to banks and securities firms, and 219 percent of
their exposure to hedge funds. The high coverage of hedge fund
exposures occurs because banks take `initial margin' on
transactions with hedge funds, in addition to fully securing
any current credit exposure. Coverage of corporate, monoline
and sovereign exposures is much less.''\101\
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\100\Rama Conti, Columbia University, Credit Derivatives: Systemic
Risk and Policy Options, 2009.
\101\Comptroller of the Currency, Quarterly Report on Bank Trading
and Derivatives Activities, 12/18/09.
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With appropriate collateral and margin requirements, a
central clearing organization can substantially reduce
counterparty risk and provide an organized mechanism for
clearing transactions. For uncleared swaps, regulators should
establish margin requirements. In addition, regulators should
also impose capital requirements on swap dealers and major swap
participants. While large losses are to be expected in
derivatives trading, if those positions are fully margined
there will be no loss to counterparties and the overall
financial system and none of the uncertainty about potential
exposures that contributed to the panic in 2008.
Exchange trading as a price transparency mechanism: ``While
central clearing would mitigate counterparty risk, central
clearing alone is not enough. Exchange trading is also
essential in order to provide price discovery, transparency,
and meaningful regulatory oversight of trading and
intermediaries,'' said Former CFTC Chairman Brooksley
Born.\102\ Exchange trading can provide pre- and post-trade
transparency for end users, market participants, and
regulators. When swaps are executed on the basis of robust
price information, rather than privately quoted, the cost of
those transactions can be reduced over time. ``The relative
opaqueness of the OTC market implies that bid/ask spreads are
in many cases not being set as competitively as they would be
on exchanges. This entails a loss in market efficiency,'' wrote
Stanford University Professor Darrel Duffie.\103\ Trading more
derivatives on regulated exchanges should be encouraged because
it will result in more price transparency, efficiency in
execution, and liquidity. In order to allow the OTC market to
adapt to more exchange-trading, the legislation provides for
``alternative swap execution facilities'' (``ASEF'') to fulfill
the exchange-trading mandate. The absence of an exchange
trading mandate provides ``supra-normal returns paid to the
dealers in the closed OTC derivatives market [and] are
effectively a tax on other market participants, especially
investors who trade on open, public exchanges,'' according to
International Risk Analytics co-founder Christopher
Whalen.\104\ Resistance to price transparency in the financial
markets has been overcome in the past, as noted by Duffie:
``About 6 years ago, a post-trade reporting system known as
TRACE was forced by U.S. regulation into the OTC markets for
corporate and municipal bonds, which operate in a manner that
is otherwise similar to the OTC derivatives markets. Dealers
resisted the introduction of TRACE, claiming that more price
transparency would reduce the incentives of dealers to make
markets and in the end reduce market liquidity. So far,
empirical evidence appearing in the academic literature has not
given much support to these claims.''\105\
---------------------------------------------------------------------------
\102\Former CFTC Chairman Brooksley Born, Joint Economic Committee
testimony, 12/1/09.
\103\Stanford University Professor Darrel Duffie, The Road Ahead
for the Fed, 2009.
\104\International Risk Analytics co-founder Christopher Whalen,
Senate Banking Committee testimony, 6/22/09.
\105\Stanford University Professor Darrel Duffie, Pew Research,
2009.
---------------------------------------------------------------------------
Allow for some customized, bilateral contracts: Some parts
of the OTC market may not be suitable for clearing and exchange
trading due to individual business needs of certain users.
Those users should retain the ability to engage in customized,
uncleared contracts while bringing in as much of the OTC market
under the centrally cleared and exchange-traded framework as
possible. Also, OTC (contracts not cleared centrally) should
still be subject to reporting, capital, and margin requirements
so that regulators have the tools to monitor and discourage
potentially risky activities, except in very narrow
circumstances. These exceptions should be crafted very narrowly
with an understanding that every company, regardless of the
type of business they are engaged in, has a strong commercial
incentive to evade regulatory requirements. ``Every firm has
reasons why its contracts are `exceptional' and should trade
privately; in reality, most derivatives contracts are
standardized--or standardizable--and could trade on
exchanges,'' said Joe Dear, Chief Investment Officer of the
California Public Employees' Retirement System.\106\
---------------------------------------------------------------------------
\106\Chief Investment Officer of the California Public Employees'
Retirement System Joe Dear, National Press Club speech, 11/3/09.
---------------------------------------------------------------------------
Therefore, the legislation permits regulators to exempt
contracts from the clearing and exchange trading requirement
based on these narrow criteria: one counterparty is not a swap/
security-based swap dealer or major swap/security-based swap
participant and does not meet the eligibility requirements of a
clearinghouse. If no clearinghouse, board of trade, exchange,
or alternative swap execution facility accepts the contract for
clearing or trading, then the contract must be exempt from the
clearing and exchange trading requirements. The regulators may
also exempt swaps from the margin requirement for uncleared
swaps under the following narrow criteria: one counterparty is
not a swap/security-based swap dealer or major swap/security-
based swap participant, using the swap as part of an effective
hedge under generally accepted accounting principles, and
predominantly engaged in activities that are not financial in
nature. Regulators must notify the Financial Stability
Oversight Council before issuing any permissive exemptions.
In providing exemptions, regulators should minimize making
distinctions between the types of firms involved in the market
or the types of products the firms are engaged in and instead
evaluate the nature of the firm's derivatives activity: ``[T]wo
complementary regulatory regimes must be implemented: one
focused on the dealers that make the markets in derivatives and
one focused on the markets themselves--including regulated
exchanges, electronic trading systems and clearing houses . . .
These two regimes should apply no matter which type of firm,
method of trading or type of derivative or swap is involved,''
testified Chairman Gensler.\107\ To achieve the objectives of
regulatory reform in the OTC market,``it is critical that
similar products and activities be subject to similar
regulations and oversight.''\108\ In determining whether to
bring non-swap dealers into the regulatory framework,
regulators should focus on counterparty credit exposure. It was
counterparty credit risk that played a critical role in
exacerbating the 2008 crisis. Regulators would measure credit
exposure by evaluating the value of collateral held against
such exposure. According to the Office of the Comptroller of
the Currency, ``the first step to measuring credit exposure in
derivative contracts involves identifying those contracts where
a bank would lose value if the counterparty to a contract
defaulted today . . . A more risk sensitive measure of credit
exposure would also consider the value of collateral held
against counterparty exposures.''\109\
---------------------------------------------------------------------------
\107\Chairman Gensler, Senate Banking Committee testimony, 6/22/09.
\108\Obama Administration white paper, Financial Regulatory Reform:
A New Foundation, June 2009.
\109\Comptroller of the Currency, Quarterly Report on Bank Trading
and Derivatives Activities, 12/18/09.
---------------------------------------------------------------------------
INVESTOR PROTECTION
Title IX addresses a number of securities issues, including
provisions that respond to significant aspects of the financial
crisis caused by poor securitization practices (Subtitle D);
erroneous credit ratings (Subtitle C); ineffective SEC
regulation of Madoff Securities, Lehman Brothers and other
firms (Subtitle F); and executive compensation practices that
promoted excessive risk-taking (Subtitle E). In connection with
the crisis, concerns have also been raised that investors need
more protection; shareholders need a greater voice in corporate
governance; the SEC needs more authority; the SEC should be
self-funded; and the municipal securities markets need improved
regulation, which are addressed here as well.
Significant aspects of the financial crisis involved
securities. Serious and far reaching problems were caused by
poor and risky securitization practices; erroneous credit
ratings; ineffective SEC regulation of investment banks such as
Lehman Brothers and broker dealers such as Madoff; and
excessive compensation incentives that promoted excessive risk
taking. During the crisis, it became apparent that investors
needed better protection, shareholders needed more voice in
corporate governance, the municipal securities markets needed
improved regulation, and the SEC needs assistance. Title IX
addresses these and other investor protection and related
securities issues.
Credit ratings that vastly understated the risks of complex
mortgage-backed securities encouraged the build-up of excessive
leverage and credit risk throughout the financial system in the
years before the crisis. With the onset of the crisis, the
ratings of many mortgage-backed bonds were sharply downgraded,
fuelling widespread uncertainty about asset values and
amplifying problems in residential mortgage markets into a
global financial panic. The rating agencies' errors can be
attributed to overreliance on mathematical risk models based on
inadequate data and to conflicts of interest in the process of
rating complex structured securities, where the rating agencies
actually advised the issuers on how to obtain AAA ratings,
without which the securities could not have been sold.
This legislation will improve the regulation and
performance of credit rating agencies by enhancing SEC
oversight authority and requiring more robust internal
supervision of the ratings process. In addition, rating
agencies will be required to disclose more data about
assumptions and methodologies underlying ratings, in order to
permit investors to better understand credit ratings and their
limitations. Due diligence investigations into the facts
underlying ratings will be encouraged. Rating agencies will be
held accountable for failures to produce ratings with
integrity, both by allowing the SEC to suspend rating agencies
that consistently fail to produce accurate ratings and by
lowering the pleading standard for private lawsuits alleging
that a rating agency knowingly or recklessly failed to conduct
a reasonable investigation of the factual elements of the rated
security, or failed to obtain reasonable verification of such
factual elements from independent sources that it considered to
be competent. Finally, the legislation requires financial
regulators to review and remove unnecessary references to
credit ratings in their regulations.
Excesses and abuses in the securitization process played a
major role in the crisis. Under the ``originate to distribute''
model, loans were made expressly to be sold into securitization
pools, which meant that the lenders did not expect to bear the
credit risk of borrower default. This led to significant
deterioration in credit and loan underwriting standards,
particularly in residential mortgages. Moreover, investors in
asset-backed securities could not assess the risks of the
underlying assets, particularly when those assets were
resecuritized into complex instruments like collateralized debt
obligations. With the onset of the crisis, there was widespread
uncertainty regarding the true financial condition of holders
of asset-backed securities, freezing interbank lending and
constricting the general flow of credit. Complexity and opacity
in securitization markets prolonged and deepened the crisis,
and have made recovery efforts much more difficult.
This title requires securitizers to retain an economic
interest in a material portion of the credit risk for any asset
that securitizers transfer, sell, or convey to a third party.
This ``skin in the game'' requirement will create incentives
that encourage sound lending practices, restore investor
confidence, and permit securitization markets to resume their
important role as sources of credit for households and
businesses.
Congress is empowering shareholders in a public company to
have a greater voice on executive compensation and to have more
fairness in compensation affairs. Under the new legislation,
each publicly traded company would give its shareholders the
right to cast advisory votes on whether they approve of its
executive compensation. The board committee that sets
compensation policy would consist only of directors who are
independent. The company would tell shareholders about the
relationship between the executive compensation it paid and its
financial performance. The company would be required to have a
policy to recover money that it erroneously paid to executives
based on financials that later had to be restated due to an
accounting error.
Management nominees for directors of public companies could
generally serve on the board only if they won a majority of the
votes in an uncontested election. Also, the S.E.C. would have
the authority to allow shareholders to have more power in
governing the public companies in which they own stock. If the
S.E.C. gives shareholders proxy access, a shareholder who has
owned an amount of stock for a period of time, as specified by
the S.E.C., could choose a candidate to nominate for election
to the board of directors on the company's proxy.
Investors would have new sources of assistance. The new
Office of Investor Advocate housed within the SEC would help
retail investors with problems they have with the SEC or self-
regulatory organizations. Securities broker-dealers, such as
Bernard L. Madoff Investment Securities, would have to use
auditors that are subject to the inspections and discipline by
a rigorous regulator, the Public Company Accounting Oversight
Board, which would better protect investor accounts. Larger
investors would have to post margin collateral based on the net
positions in their securities and futures portfolio. An
Investment Advisory Committee is created in the law to give
advice to the SEC from its members, which would include
representatives of mutual fund, stock and bond investors,
senior citizens, State securities regulators, and others. The
law increases the amount of money available to the Securities
Investor Protection Corporation to pay off valid claims of
customers of defunct broker-dealers.
The SEC would get more power, assistance and money at its
disposal to be an effective securities markets regulator. The
SEC would have new authority to impose limitation on mandatory
arbitration; to bar someone who violated the securities laws
while working for one type of registered securities firm, such
as a broker-dealer, from working for other types of securities
firms, such as investment advisers; to require that securities
firms give new disclosures to investors before they buy
investment products. The SEC would have more help in
identifying securities law violations through a new, robust
whistleblower program designed to motivate people who know of
securities law violations to tell the SEC. It also expands
existing whistleblower law. In light of recent failures of the
SEC, the GAO will also provide assistance through studies and
recommendations to improve the agency's internal supervisory
controls, management and financial controls. The SEC has asked
to be unfettered by the Congressional appropriation process and
the new law would allow the agency to be self-funded.
A major lesson from the crisis is the importance of
transparency in financial markets. The $3 trillion municipal
securities market is subject to less supervision than corporate
securities markets, and market participants generally have less
information upon which to base investment decisions. During the
crisis, a number of municipalities suffered losses from complex
derivatives products that were marketed by unregulated
financial intermediaries. This title requires a range of
municipal financial advisors to register with the SEC and
comply with regulations issued by the Municipal Securities
Rulemaking Board (MSRB). The composition of the MSRB will be
changed so that representatives of the public--including
investors and municipalities--make up a majority of the board.
In addition, the title establishes an Office of Municipal
Securities within the SEC and contains a number of studies on
ways to improve disclosure, accounting standards, and
transparency in the municipal bond market.
REGULATION OF PRIVATE FUNDS
Title IV requires advisers to large hedge funds to register
with the Securities and Exchange Commission, in order to close
a significant gap in financial regulation. Because hedge funds
are currently unregulated, no precise data regarding the size
and scope of hedge fund activities are available, but the
common estimate is that the funds had at least $2 trillion in
capital before the crisis. Their impact on the financial system
can be magnified by extensive use of leverage--their trades can
move markets. While hedge funds are generally not thought to
have caused the current financial crisis, information regarding
their size, strategies, and positions could be crucial to
regulatory attempts to deal with a future crisis. The case of
Long-Term Capital Management, a hedge fund that was rescued
through Federal Reserve intervention in 1998 because of
concerns that it was ``too-interconnected-to-fail,'' shows that
the activities of even a single hedge fund may have systemic
consequences.
Hedge fund registration was part of the Treasury's
Department's regulatory reform proposal, and has been endorsed
by many witnesses before the Committee, including Mr. James
Chanos, Chairman of the Coalition of Private Investment
Companies, who testified that ``private funds (or their
advisers) should be required to register with the SEC. . . .
Registration will bring with it the ability of the SEC to
conduct examinations and bring administrative proceedings
against registered advisers, funds, and their personnel. The
SEC also will have the ability to bring civil enforcement
actions and to levy fines and penalties for violations.''\110\
Other supporters of the title include a range of industry
groups, institutional investors, the Group of Thirty, the G-20,
and the Investors' Working Group.
---------------------------------------------------------------------------
\110\Testimony of James Chanos, Chairman, Coalition of Private
Investment Companies, to the Senate Banking Committee, 7/15/09.
---------------------------------------------------------------------------
In addition to SEC registration, this title requires
private funds--hedge funds with more than $100 million in
assets under management--to disclose information regarding
their investment positions and strategies. The required
disclosures include information on fund size, use of leverage,
counterparty credit risk exposure, trading and investment
positions, valuation policies, types of assets held, and any
other information that the SEC, in consultation with the
Financial Stability Oversight Council, determines is necessary
and appropriate to protect investors or assess systemic risk.
The Council will have access to this information to monitor
potential systemic risk, while the SEC will use it to protect
investors and market integrity.
III. BACKGROUND AND NEED FOR LEGISLATION
The statistics alone reveal the terrible toll the financial
crisis exacted on the U.S. economy. From the start of the
crisis through March 2010, more than 8 million jobs were
lost.\111\ Unemployment in the United States reached 10.1% in
October 2009, the highest rate of unemployment since 1983, and
as of March 2010 was holding at 9.7%; prior to the economic
collapse, in October 2008, the unemployment rate was just
6.6%.\112\ American household wealth fell by more than $13
trillion from the peak value of American wealth in 2007 to the
height of the crisis at the end of 2008. Even after several
months of recovery, household wealth is still down $11
trillion, or almost 17%, from its 2007 peak.\113\ Home prices
have dropped 30.2% from their 2006 peak,\114\ and retirement
assets dropped by more than 20%. Real Gross Domestic Product in
the United States in the fourth quarter of 2008, and the first
and second quarters of 2009 decreased by an annual rate of
about 5.4%, 6.4%, and 0.7%, respectively, from the previous
periods, and Real GDP through 2009 had not reached the levels
seen prior to the economic collapse.\115\ More than 7 million
homes in America have entered foreclosure since the beginning
of 2007.\116\
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\111\Bureau of Labor Statistics, database of seasonally adjusted
total nonfarm payroll, www.bls.gov.
\112\Bureau of Labor Statistics, database of seasonally adjusted
unemployment rate, 16 years and older, www.bls.gov.
\113\The Federal Reserve, Flow of Funds report, 3/11/10,
www.federalreserve.gov.
\114\S&P/Case-Shiller Home Prices Indices, 20-City Composite, press
release, 3/30/10, www.standardandpoors.com.
\115\Bureau of Economic Analysis, Gross Domestic Product: Fourth
Quarter 2009 press release, 3/26/10, www.bea.gov.
\116\Reuters News, January 29, 2008; January 15, 2009; January 14,
2010; March 11, 2010.
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Behind the statistics are hardworking men and women whose
lives have been shattered, small businesses that have been
shuttered, retirement funds that have evaporated, and families
who have lost their homes. While some of the most prominent
American financial institutions have been destroyed or badly
weakened, it is the millions of American families, who did
nothing wrong, who have suffered the most. Indeed, the
financial crisis has torn at the very fiber of our middle
class.
This devastation was made possible by a long-standing
failure of our regulatory structure to keep pace with the
changing financial system and prevent the sort of dangerous
risk-taking that led us to this point, propelled by greed,
excess, and irresponsibility. The United States' financial
regulatory structure, constructed in a piecemeal fashion over
many decades, remains hopelessly inadequate to handle the
complexities of modern finance. In January 2009, the GAO added
the U.S. financial regulatory system to its list of high-risk
areas of government operations because of its fragmented and
outdated structure.\117\
---------------------------------------------------------------------------
\117\GAO, High Risk Series: An Update, GAO-09-271 (Washington,
D.C.: Jan. 2009).
---------------------------------------------------------------------------
Rather than taking measures to strengthen the financial
services sector, some of our regulators actively embraced
deregulation, pushed for lower capital standards, ignored calls
for greater consumer protections and allowed the companies they
supervised to use complex financial instruments to manage risk
that neither they nor the companies really understood.
Moreover, many actors in the financial system--the ``shadow''
banking system--have escaped any form of meaningful regulation.
As former Comptroller of the Currency Eugene Ludwig testified,
``The paradigm of the last decade has been the conviction that
un- or under-regulated financial services sectors would produce
more wealth, net-net. If the system got sick, the thinking
went, it could be made well through massive injections of
liquidity. This paradigm has not merely shifted--it has
imploded.''\118\
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\118\Testimony before the Senate Committee on Banking, Housing, and
Urban Affairs, 10/16/08.
---------------------------------------------------------------------------
The financial crisis can trace its origins to a downturn in
the housing market that in turn exposed a raft of unsound
lending practices. These practices ultimately led to the
failure of a number of companies heavily involved in making or
investing in subprime loans. On April 2, 2007, New Century
Financial Corporation, a leading subprime mortgage lender,
filed for Chapter 11 bankruptcy. Quickly, the first signs of
trouble in the housing market came to Wall Street. In June of
2007, Bear Stearns suspended redemptions from one of its funds
and in July of 2007, Bear Stearns liquidated two of its hedge
funds that were heavily invested in mortgage-backed securities.
On August 6, a large retail mortgage lender, American Home
Mortgage Investment Corporation, filed for Chapter 11
bankruptcy. In December of 2007, the Federal Reserve, after
announcing several cuts to interest rates of both the federal
funds rate and the primary credit rate over the previous
months, announced the creation of a Term Auction Facility to
address pressures in the short-term funding markets. In March
of 2008, the Federal Reserve announced an additional short-term
lending facility, the Term Securities Lending Facility to
promote liquidity in the financial markets.\119\
---------------------------------------------------------------------------
\119\Federal Reserve Bank of St. Louis, ``The Financial Crisis--A
Timeline of Events and Policy Actions.''
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On March 14, 2008, the first major shock wave spread across
Wall Street when the Federal Reserve announced the bailout of
Bear Stearns through an arrangement with JPMorgan Chase. Bear
Stearns, whose assets were concentrated in mortgage-backed
securities, faced a major liquidity crisis as it failed to find
buyers for its now-toxic assets. Just days later, on March 16,
JPMorgan Chase agreed to buy all of Bear Stearns with
assistance from the Federal Reserve.\120\
---------------------------------------------------------------------------
\120\Ibid.
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In the months that followed the crisis grew more severe. On
July 11, 2008, the OTS closed IndyMac BankFSB, a large thrift
saddled with nonperforming mortgages. IndyMac had relied on an
``originate-to-distribute'' model of mortgage lending,\121\
under which it originated loans or brought them from others,
and then packaged them together in securities and sold them on
the secondary market to banks, thrifts, or Wall Street
investment banks.\122\ By securitizing and selling its loans,
IndyMac could shift the risk of borrower defaults onto others.
This business model led to significant deterioration in its
credit and loan underwriting standards. Accordingly, , when
housing prices declined and the secondary market collapsed
IndyMac was left with a large number of nonperforming mortgages
in its portfolio which was the primary cause of its
failure.\123\
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\121\In an ``originate-to-distribute'' model, for the most part,
the originator of mortgages sells the mortgages to a person who
packages the loans into securities and sells the securities to
investors. By selling the mortgages, the originator thus gets more
funds to make more loans. However, the ability to sell the mortgages
without retaining any risk, also frees up the originator to make risky
loans, even those without regard to the borrower's ability to repay. In
the years leading up to the crisis, the originator was not penalized
for failing to ensure that the borrower was actually qualified for the
loan, and the buyer of the securitized debt had little detailed
information about the underlying quality of the loans.
\122\Material Loss Review of IndyMac Bank, FSB (OIG-09-032); Office
of Inspector General, U.S. Department of Treasury.
\123\``The primary causes of IndyMac's failure were largely
associated with its business strategy of originating and securitizing
Alt-A loans on a large scale. This strategy resulted in rapid growth
and a high concentration of risky assets.'' Id. ``IndyMac's aggressive
growth strategy, use of Alt-A and other nontraditional loan products,
insufficient underwriting, credit concentrations in residential real
estate in the California and Florida markets, and heavy reliance on
costly funds borrowed from the Federal Home Loan Bank (FHLB) and from
brokered deposits, led to its demise when the mortgage market declined
in 2007. IndyMac often made loans without verification of the
borrower's income or assets, and to borrowers with poor credit
histories. Appraisals obtained by IndyMac on underlying collateral were
often questionable as well. As an Alt-A lender, IndyMac's business
model was to offer loan products to fit the borrower's needs, using an
extensive array of risky option-adjustable-rate-mortgages (option
ARMs), subprime loans, 80/20 loans, and other nontraditional products.
Ultimately, loans were made to many borrowers who simply could not
afford to make their payments.'' Id.
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Later in July 2008, regulators and lawmakers made several
moves to stabilize government-sponsored entities Fannie Mae and
Freddie Mac; the Federal Reserve authorized emergency lending
by the Federal Reserve Bank of New York (FRBNY) and; the
Securities and Exchange Commission temporarily prohibited naked
short-selling in securities; President Bush signed into law the
Housing and Economic Recovery Act of 2008 which allowed the
Treasury Department to purchase GSE obligations and created a
new regulatory regime for the entities--the Federal Housing
Finance Agency (FHFA). Ultimately, on September 7, FHFA placed
both Fannie Mae and Freddie Mac into government
conservatorship.\124\
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\124\Federal Reserve Bank of St. Louis, ``The Financial Crisis--A
Timeline of Events and Policy Actions.''
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September 15, 2008 saw two more icons of Wall Street
collapse and ushered in a period of extraordinary government
intervention to prevent a complete financial meltdown, the
depths of which, according to Federal Reserve Board Chairman
Ben Bernanke, ``could have rivaled or surpassed the Great
Depression.''\125\ Bank of America announced its plan to
purchase Merrill Lynch, and Lehman Brothers filed for
bankruptcy, unable to find a buyer. The following day, the
Federal Reserve authorized the FRBNY to provide the American
International Group with up to $85 billion of emergency lending
(the FRBNY was authorized to lend an additional $37.8 billion
to AIG on October 6 and later the Treasury Department would
purchase $40 billion of AIG preferred shares through the TARP
program). On September 17, the SEC announced a ban on short-
selling of all stocks of financial sector companies. On
September 21, the Federal Reserve accepted applications from
investment banking companies Goldman Sachs and Morgan Stanley
to become bank holding companies, allowing them access to the
federal safety net. From September 12 to October 10, the Dow
Jones Industrial Average dropped 26%. Major bank failures
continued, with the OTS closing Washington Mutual on September
25, and facilitating its acquisition by JPMorgan Chase.
Wachovia bank also faced collapse, forcing it to find a buyer;
ultimately Wells Fargo purchased the bank on October 12.\126\
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\125\Speech to the 43rd Annual Alexander Hamilton Awards Dinner,
Center for the Study of the Presidency and Congress, Washington, D.C.,
4/8/10.
\126\Federal Reserve Bank of St. Louis, ``The Financial Crisis--A
Timeline of Events and Policy Actions.''
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While Wall Street was reeling, lawmakers worked to craft an
emergency measure to stabilize the markets and halt the
momentum of the crisis. On September 20, Treasury Secretary
Henry Paulson delivered to Capitol Hill his proposal for the
Emergency Economic Stabilization Act. Nine days later, the
House of Representatives voted down a modified version of the
Treasury Department proposal. On that day, the Dow Jones
Industrial Average fell by more than 750 points.\127\ The
Senate later acted to pass a further modified measure including
comprehensive oversight, help for homeowners, and corporate
governance requirements not included in the Treasury Department
proposal. The bill was signed into law by President Bush on
October 3, 2008, establishing the $700 billion Troubled Asset
Relief Program (TARP).
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\127\Dow Jones Indexes, Index Data, www.djaverages.com.
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As a result of the crisis, in addition to the losses of
homes, family savings, and jobs, the government became a
reluctant, but major shareholder of private banks, automobile
companies, and other giants of the economy. The TARP program
was enacted to provide the government with a critical tool
needed to wrest the economy from a free-fall. But with the
passage of TARP, the Congress granted the Treasury Department
extraordinary powers and a staggering sum of taxpayer money to
address a crisis that was brought on by the failures of the
very banks that benefited from the program and by the
government regulators that failed at their jobs. While this
extent of government intervention was necessary to avert a
complete collapse of the U.S. economy, our nation should never
again be put in the position of having to bail out big
companies.
The consequences of the crisis could not be more evident,
from the failures on Wall Street to the devastation on Main
Street and across the globe. Its myriad causes however, are
buried in a patchwork of problems touching on almost every
aspect of the financial services sector. Throughout the course
of its work over the past 40 months, the Committee probed and
evaluated the causes of the economic downfall in order to
develop a legislative response that prevents a recurrence of
the same problems and that creates a new regulatory framework
that can respond to the challenges of a 21st century
marketplace.
Causes of the Financial Crisis
The crisis was first triggered by the downturn in the
national housing market, leading to an overall housing slump.
This slump brought into focus the prevalence of unsound lending
practices, including predatory lending tactics, most often in
the subprime market. Many of these practices, and the products
that ultimately spread the risks associated with these
practices, existed in what came to be known as the shadow
banking system, a structure that eluded regulation and
oversight despite its prevalence in the financial marketplace.
Though the market for subprime mortgages was less than 1%
of global financial assets, the faults in the system allowed
the turmoil in the housing market to spill over into other
sectors. Faults in the system included a securitization process
that fueled excessive risk taking by permitting mortgage
originators to quickly sell the unsuitable loans they made, and
thereby transfer the risks to someone else; credit rating
agencies that gave inflated ratings to securities backed by
risky mortgage loans; and the use of unregulated derivatives
products based on these faulty loans that only served to spread
and magnify the risk. The system operated on a wholesale
misunderstanding of, or complete disregard for the risks
inherent in the underlying assets and the complex instruments
they were backing. Explaining the rise in complex financial
products and their danger to the financial system, Eugene
Ludwig testified to the Committee, ``Technology, plus
globalization, plus finance has created something quite new,
often called `financial technology.' Its emergence is a bit
like the discovery of fire--productive and transforming when
used with care, but enormously destructive when
mishandled.''\128\
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\128\Testimony before the Senate Committee on Banking, Housing, and
Urban Affairs, 10/16/08.
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Gaps in the regulatory structure allowed these risks and
products to flourish outside the view of those responsible for
overseeing the financial system. Many major market
participants, such as AIG, were not subject to meaningful
oversight by federal regulators. Additionally, no financial
regulator was responsible for assessing the impact the failure
of a single firm might have on the state of the financial
system. Indeed, as the crisis grew more severe, the
interconnected relationships among financial companies
increased the pressure on those already struggling to survive,
which only served to accelerate the downfall of some firms. For
example, as AIG's position worsened, it was required to post
more collateral to its counterparties and to increase its
capital holdings as required by regulators.
Fueling the loss of confidence in the system was the
failure of regulators and market participants to fully
understand the extent of the obligations of these teetering
firms, thus making an orderly shutdown of these companies
nearly impossible. When Lehman Brothers declared bankruptcy,
the markets panicked and the crisis escalated. With no other
means to resolve large, complex and interconnected financial
firms, the government was left with few options other than to
provide massive assistance to prop up failing companies in an
effort to prevent the crisis from spiraling into a great
depression.
Despite initial efforts of the government, credit markets
froze and the U.S problem spread across the globe. The crisis
on Wall Street soon spilled over onto Main Street, touching the
lives of most Americans and devastating many.
IV. HISTORY OF THE LEGISLATION
From the beginning of the 110th Congress, the work of the
Senate Committee on Banking, Housing and Urban Affairs focused
on the problems in the housing market that started with the
spread of predatory lending and culminated in the turmoil in
the credit markets that led to the economic crisis of 2008 and
2009. This work led to the drafting and committee passage of
the Restoring American Financial Stability Act in March 2010.
The Committee's first official examination of the housing
crisis began with a hearing in February 2007, titled
``Preserving the American Dream: Predatory Lending Practices
and Home Foreclosures'' which featured testimony from
representatives of the mortgage industry, consumer advocates,
and victims of predatory lending. The next month, the Committee
followed up with a hearing to explore problems in the mortgage
market--``Mortgage Market Turmoil: Causes and Consequences.''
The hearing featured testimony from federal and state banking
regulators as well as representatives from industry and
consumers.
As the crisis evolved and leading up to Committee passage
of RAFSA, the Committee held nearly 80 hearings to both examine
the causes of the housing and economic crisis and assess how
best to stabilize the nation's financial services industry and
capital markets, while lessening the impact of the crisis on
Main Street Americans. In the immediate aftermath of the
collapse of Bear Stearns, the Committee held 8 hearings on the
``Turmoil in the U.S. Credit Markets'' and the foreclosure
crisis. Upon the collapse of Lehman Brothers, the Committee
held another series of hearings on the economic turmoil,
including on the Bush Administration's proposed legislation
that eventually became the ``Emergency Economic Stabilization
Act of 2008.'' The Committee has held a series of oversight
hearings on the implementation of that Act since its passage as
well as on other extraordinary measures the financial
regulatory agencies have taken, including the Federal Reserve,
to stabilize the economy.
Beginning in February 2009, the Committee began its first
of more than 50 hearings to assess the types of reforms needed
to protect the economy from another devastating financial
crisis. The Committee held comprehensive hearings on how to end
the abuses and loopholes that led the country into the current
crisis. Hearings explored all specific elements of the
financial reform legislation, as well as specific regulatory
failures that contributed to the crisis.
With an eye toward drafting comprehensive legislation, the
Committee held hearings on prudential bank supervision,
systemic risk, ending taxpayer bailouts of companies perceived
to be ``too big to fail,'' consumer protection, derivatives
regulation, investor protection, private investment pools,
insurance regulation and government-sponsored entities.
Throughout its examinations, the Committee took testimony from
regulators, policy experts, industry representatives, and
consumer advocates.
In looking at the consequences of the crisis, the Committee
examined how the crisis affected sectors all across the
financial services industry and the Main Street economy. Areas
covered, aside from the overall state of the banking, housing
and securities industries, included the impact on community
banks and credit unions, manufacturing, international aspects
of regulation, consumers, and the effect on homeownership.
To learn from the mistakes of the past, the Committee
thoroughly examined factors that led to the crisis. These
hearings began with investigations into the problems associated
with subprime and predatory lending, and continued with
hearings including the failure of AIG, investment fraud
including the Bernard Madoff and Allen Stanford cases, the
actions of credit ratings agencies, failures of regulators,
problems of risk management oversight, and the role of
securitization in the financial crisis.
In the spring of 2009, the Obama Administration released a
set of its proposals for financial regulatory reform. On June
18, 2009, the Committee held a hearing, ``The Administration's
Proposal to Modernize the Financial Regulatory System,'' to
examine the President's ideas for reforms, including testimony
from Treasury Secretary Timothy Geithner. This hearing was
followed by two hearings on additional proposals from the
Administration in the start of 2010, titled ``Prohibiting
Certain High-Risk Investment Activities by Banks and Bank
Holding Companies'' and ``Implications of the `Volcker Rules'
for Financial Stability.'' These hearings included testimony
from Deputy Secretary Neal S. Wolin and Presidential Economic
Recovery Advisory Board Chairman and former Federal Reserve
Board Chairman Paul Volcker.
On November 10, 2009, Banking Committee Chairman
Christopher Dodd introduced to his colleagues a discussion
draft of financial reform legislation, based on the Committee's
extensive hearing record, numerous briefings and meetings, as
well as the Administration's proposal. Introducing the draft,
Chairman Dodd said:
It is the job of this Congress to restore
responsibility and accountability in our financial
system to give Americans confidence that there is a
system in place that works for and protects them. . . .
The financial crisis exposed a financial regulatory
structure that was the product of historic accident,
created piece by piece over decades with little thought
given to how it would function as a whole, and unable
to prevent threats to our economic security. . . . I
will not stand for attempts to protect a broken status
quo, particularly when those attempts are made by some
of the same special interests who caused this mess in
the first place.
The Committee convened on November 19, 2009, to begin
consideration of the Restoring American Financial Stability Act
of 2009. The Committee met only to receive opening statements
from members. Based on the opening statements, the Chairman
decided to postpone further consideration of the legislation,
pending the outcome of various bipartisan working groups the
Chairman assembled to consider significant aspects of the
legislation.
On March 16, 2010, following more than 80 hearings with
testimony from hundreds of experts and months of negotiations
with both Republicans and Democrats on the Banking Committee,
Chairman Dodd unveiled the financial reform proposal that he
would introduce to the Committee. One week later, on March 22,
the Committee met and passed the bill by a vote of 13 to 10, as
amended with a single manager's amendment. No additional
amendments were offered.
V. SECTION-BY-SECTION ANALYSIS
Title I--Financial Stability
Section 101. Short title
The title may be cited as the ``Financial Stability Act of
2010.''
Section 102. Definitions
This section defines various terms used in the title,
including ``bank holding company,'' ``member agency,''
``nonbank financial company,'' ``Office of Financial
Research,'' and ``significant nonbank financial company.''
``Nonbank financial companies'' are defined as companies
substantially engaged in activities that are financial in
nature (as defined in section 4(k) of the Bank Holding Company
Act of 1956), excluding bank holding companies and their
subsidiaries. ``Nonbank financial companies supervised by the
Board of Governors'' refer to those nonbank financial companies
that the Financial Stability Oversight Council (``Council'')
has determined shall be supervised by the Board of Governors of
the Federal Reserve System (``Board of Governors'') under
section 113 and subject to prudential standards authorized
under this title.
This section requires the Board of Governors to establish
by rulemaking the criteria for determining whether a company is
substantially engaged in financial activities to qualify as a
nonbank financial company. It is intended that commercial
companies, such as manufacturers, retailers, and others, would
not be considered to be nonbank financial companies generally,
and this provision is intended to provide certainty by
mandating the establishment of the criteria through the public
notice and comment process required for rulemaking.
This section provides that the Board of Governors will
define the term ``significant bank holding company'' and
``significant nonbank financial company'' through rulemaking.
It is not intended that securities or futures exchanges
regulated by the SEC and the CFTC that act as administrators of
marketplaces be considered a ``significant nonbank financial
company,'' which term is used in this title with respect to
counterparty exposure, to the extent the exchanges do not act
as a counterparty (and thus do not create credit exposures).
This section also clarifies that with respect to foreign
nonbank financial companies, references to ``company'' and
``subsidiary'' include only the United States activities and
subsidiaries of such foreign companies.
Subtitle A--Financial Stability Oversight Council
Section 111. Financial Stability Oversight Council established
This section establishes the Council, consisting of the
following voting members: (1) the Secretary of the Treasury,
who will serve as the Chairperson (``Chairperson'') of the
Council, (2) the Chairman of the Board of Governors (``Board of
Governors'') of the Federal Reserve System, (3) the Comptroller
of the Currency, (4) the Director of the Bureau of Consumer
Financial Protection, (5) Director of the Federal Housing
Finance Agency, (6) the Chairman of the Securities and Exchange
Commission, (7) the Chairperson of the Federal Deposit
Insurance Corporation (``FDIC''), (8) the Chairperson of the
Commodity Futures Trading Commission, and (9) an independent
member (appointed by the President, with the advice and consent
of the Senate) having insurance expertise.
The Director of the Office of Financial Research (which is
established under subtitle B) will serve in an advisory
capacity as a nonvoting member. The Council will meet at the
call of the Chairperson or majority of the members then
serving, but not less frequently than quarterly. Any employee
of the Federal government may be detailed to the Council, and
any department or agency of the United States may provide the
Council such support services the Council may determine
advisable.
Section 112. Council authority
This section enumerates the purposes of the Council, which
include: (1) identifying risks to the financial stability of
the United States that could arise from the material financial
distress or failure of large, interconnected bank holding
companies or nonbank financial companies; (2) promoting market
discipline, by eliminating expectations on the part of
shareholders, creditors, and counterparties of such companies
that the government will shield them from losses in the event
of failure; and (3) responding to emerging threats to the
stability of the United States financial markets.
The duties of the Council include: (1) collecting
information from member agencies and other regulatory agencies,
and, if necessary to assess risks to the United States
financial system, directing the Office of Financial Research to
collect information from bank holding companies and nonbank
financial companies; (2) providing direction to, and requesting
data and analyses from, the Office of Financial Research to
support the work of the Council; (3) monitoring the financial
services marketplace to identify threats to U.S. financial
stability; (4) facilitating information sharing among the
member agencies; (5) recommending to member agencies general
supervisory priorities and principles reflecting the outcome of
discussions among the member agencies; (6) identifying gaps in
regulation that could pose risks to U.S. financial stability;
(7) requiring supervision by the Board of Governors for nonbank
financial companies that may pose risks to the financial
stability of the U.S. in the event of their material financial
distress or failure; (8) making recommendations to the Board of
Governors concerning the establishment of heightened prudential
standards for risk-based capital, leverage, liquidity,
contingent capital, resolution plans and credit exposure
reports, concentration limits, enhanced public disclosures, and
overall risk management for nonbank financial companies and
large, interconnected bank holding companies supervised by the
Board of Governors; (9) identifying systemically important
financial market utilities and payments, clearing, and
settlement system activities and subjecting them to prudential
standards established by the Board of Governors; (10) making
recommendations to primary financial regulatory agencies to
apply new or heightened standards and safeguards for financial
activities or practices that could create or increase risks of
significant liquidity, credit, or other problems spreading
among bank holding companies, nonbank financial companies, and
United States financial markets; (11) providing a forum for
discussion and analysis of emerging market developments and
financial regulatory issues, and for resolution of
jurisdictional disputes among member agencies; and (12)
reporting to and testifying before Congress.
The section also authorizes the Council to request and
receive data from the Office of Financial Research and member
agencies to carry out the provisions of this title. The
Council, acting through the Office of Financial Research, may
also require the submission of reports from financial companies
to help assess whether a financial company, activity, or market
poses a threat to U.S. financial stability. Before requiring
such reports, the Council, acting through the Office of
Financial Research, shall coordinate with the appropriate
member agency (including the Office of National Insurance
established in the Treasury Department under Title V of this
Act) or primary financial regulatory agency and shall rely,
whenever possible, on information already available from these
agencies. In the case of a foreign nonbank financial company or
a foreign-based bank holding company, it is intended that the
Council, acting through the Office of Financial Research,
consult to the extent appropriate with the applicable foreign
regulator for the company.
Section 113. Authority to require supervision and regulation of certain
nonbank financial companies
This section authorizes the Council, by a vote of not fewer
than \2/3\ of members then serving, including an affirmative
vote by the Chairperson, to determine that a nonbank financial
company will be supervised by the Board of Governors and
subject to heightened prudential standards, if the Council
determines that material financial distress at such company
would pose a threat to the financial stability of the United
States. Each determination will be based on a consideration of
enumerated factors by the Council, including, among others: the
degree of leverage (a typical mutual fund could be an example
of a nonbank financial company with a low degree of leverage);
amount and nature of financial assets; amount and types of
liabilities (which could be different types of liabilities
based on, for example, their maturity, volatility, or
stability), including degree of reliance on short-term funding;
extent and type of off-balance-sheet exposures; extent to which
assets are managed rather than owned and to which ownership of
assets under management is diffuse; the operation of, or
ownership interest in, any clearing, settlement, or payment
business of the company; and any other risk-related factors
that the Council deems appropriate. Size alone should not be
dispositive in the Council's determination; in its
consideration of the enumerated factors, the Council should
also take into account other indicia of the overall risk posed
to U.S. financial stability, including the extent of the
nonbank financial company's interconnections with other
significant financial companies and the complexity of the
nonbank financial company. It is not intended that a Council
determination be based on the exchange functions of securities
or futures exchanges regulated by the SEC and the CFTC, to the
extent that as part of these functions the exchanges act as
administrators of marketplaces and not as counterparties.
Further, it is not intended that the activities of securities
and futures exchanges overseen by the SEC and the CFTC that
consist of, or occur prior to, trade execution be considered a
``clearing, settlement or payment business,'' provided that
such activities do not include functioning as a counterparty.
The Council will provide written notice to each nonbank
financial company of its proposed determination and the company
would have the opportunity for a hearing before the Council to
contest the proposed determination. The Council will consult
with the primary federal regulatory agency of each nonbank
financial company or subsidiary of the company before making
any final determination. The section provides for judicial
review of the final determination of the Council. In case of a
foreign nonbank financial company, it is intended that the
Council consult to the extent appropriate with the applicable
foreign regulator for the company.
Section 114. Registration of nonbank financial companies supervised by
the Board of Governors
This section directs a nonbank financial company to
register with the Board of Governors if a final determination
is made by the Council under section 113 that such company is
to be supervised by the Board of Governors.
Section 115. Enhanced supervision and prudential standards for nonbank
financial companies supervised by the Board of Governors and
certain bank holding companies
This section authorizes the Council to make recommendations
to the Board of Governors concerning the establishment and
refinement of prudential standards and reporting and disclosure
requirements for nonbank financial companies supervised by the
Board of Governors pursuant to a determination under section
113 and large, interconnected bank holding companies. Such
standards and requirements must be more stringent than those
applicable to other nonbank financial companies and bank
holding companies that do not present similar risks to the
financial stability of the United States, and they must
increase in stringency as appropriate in relation to certain
characteristics of the company, including its size and
complexity. The Council may only recommend standards for bank
holding companies with total consolidated assets of $50 billion
or more, and the Council may recommend an asset threshold
greater than $50 billion for the applicability of any
particular standard. The prudential standards may include risk-
based capital requirements, leverage limits, liquidity
requirements, a contingent capital requirement, resolution plan
and credit exposure report requirements, concentration limits,
enhanced public disclosures, and overall risk management
requirements.
The section enumerates the factors that the Council shall
consider in making its recommendation, which include those
factors considered in determining whether a nonbank financial
company should be subject to supervision and prudential
standards by the Board of Governors under section 113, among
them the amounts and types of assets and liabilities, degree of
leverage, and extent of off-balance sheet exposures. In making
its recommendation, it is intended that the Council take into
account the nature of the business of different types of
nonbank financial companies as well as any existing regulatory
regime applicable to different types of nonbank financial
companies; the Committee recognizes that not all standards and
requirements may be applicable universally. With respect to the
contingent capital requirement, the Council shall conduct a
study of the feasibility, benefits, costs, and structure of
such a requirement and report to Congress not later than two
years after the date of enactment of this Act.
Section 116. Reports
Under this section, the Council, acting through the Office
of Financial Research, may require reports from nonbank
financial companies supervised by the Board of Governors
pursuant to a section 113 determination and bank holding
companies with total consolidated assets of $50 billion or more
and their subsidiaries, but must use existing reports to the
fullest extent possible.
Section 117. Treatment of certain companies that cease to be bank
holding companies
This section is intended to ensure that a bank holding
company that could pose a risk to U.S. financial stability if
it experienced material financial distress would remain
supervised by the Board of Governors and subject to the
prudential standards authorized under this title even if it
sells or closes its bank. The section applies to any entity or
a successor entity that (1) was a bank holding company having
total consolidated assets equal to or greater than $50 billion
as of January 1, 2010, and (2) received financial assistance
under or participated in the Capital Purchase Program
established under the Troubled Asset Relief Program. If such
entity ceases to be a bank holding company at any time after
January 1, 2010, then the entity will be treated as a nonbank
financial company supervised by the Board of Governors as if
the Council had made a determination under section 113. The
entity may request a hearing and appeal to the Council its
treatment as a nonbank financial company supervised by the
Board of Governors.
Section 118. Council funding
Any expenses of the Council will be treated as expenses of,
and paid by, the Office of Financial Research. (The Council
will have only one member for which it incurs salary and
benefit expenses, the independent member having insurance
expertise. All other members of the Council, and any employees
detailed to the Council, will be paid by their respective
agencies or departments.)
Section 119. Resolution of supervisory jurisdictional disputes among
member agencies
This section authorizes a dispute resolution function for
the Council. The Council shall resolve disputes among member
agencies about the respective jurisdiction over a particular
financial company, activity, or product if the agencies cannot
resolve the dispute without the Council's intervention. The
section prescribes the procedures for dispute resolution and
makes the Council's written decision binding on the member
agencies that are parties to the dispute.
Section 120. Additional standards applicable to activities or practices
for financial stability purposes
This section authorizes the Council to issue
recommendations to the primary financial regulatory agencies to
apply new or heightened prudential standards and safeguards,
including those enumerated in section 115, for a financial
activity or practice conducted by bank holding companies or
nonbank financial companies under the agencies' jurisdiction.
The Council would make such recommendation if it determines
that the conduct of the activity or practice could create or
increase the risk of significant liquidity, credit, or other
problems spreading among bank holding companies and nonbank
financial companies or U.S. financial markets. The section
requires the Council to consult with the primary financial
regulatory agencies, provide notice and opportunity for comment
on any proposed recommendations, and consider the effect of any
recommendation on costs to long-term economic growth. The
Council may recommend specific actions to apply to the conduct
of a financial activity or practice, including limits on scope
or additional capital and risk management requirements.
The Council may inform the primary financial regulatory
agency of any Council determination that a bank holding company
or nonbank financial company, activity, or practice no longer
requires any heightened standards implemented under this title.
The primary financial regulatory agency may determine whether
to keep such standards in effect, and shall promulgate
regulations to establish a procedure by which entities under
its jurisdiction may appeal the determination of the primary
financial regulatory agency.
Section 121. Mitigation of risks to financial stability
This section is intended to provide additional authority
for regulators to address grave threats to U.S. financial
stability if the prudential standards established under this
title would not otherwise do so. The section authorizes the
Board of Governors, if it determines that a nonbank financial
company supervised by the Board of Governors pursuant to a
determination under section 113 or a bank holding company with
total consolidated assets of $50 billion or more poses a grave
threat to the financial stability of the United States, to
require such company to comply with conditions on the conduct
of certain activities, terminate certain activities, or, if the
Board of Governors determines that such action is inadequate to
mitigate a threat to the financial stability of the United
States, sell or transfer assets to unaffiliated entities, with
an affirmative vote of 2/3 of the Council members then serving
and after notice and opportunity for hearing. The Board of
Governors and the Council will take into consideration the
factors set forth in section 113(a) and (b) in any
determination or decision under this section.
Subtitle B--Office of Financial Research
Section 151. Definitions
Section 152. Office of Financial Research established
This section establishes within the Treasury Department the
Office of Financial Research, (``Office'') headed by a Director
appointed by the President and confirmed by the Senate. The
Director shall serve for a term of 6 years. This section
provides the Director with certain authorities to manage the
Office and also authorizes a fellowship program to be
established.
Section 153. Purpose and duties of the Office
The purpose of the Office is to support the Council in
fulfilling the purposes and duties of the Council and to
support member agencies of the Council by (1) collecting data
on behalf of the Council and providing such data to the Council
and member agencies; (2) standardizing the types and formats of
data reported and collected; (3) performing applied research
and essential long-term research; (4) developing tools for risk
measurement and monitoring; (5) performing other related
services; (6) making the results of the activities of the
Office available to financial regulatory agencies, and (7)
assisting member agencies in determining the types and formats
of data where member agencies are authorized by this Act to
collect data. This section provides the Office with certain
administrative authorities and rulemaking authority regarding
data collection and standardization, requires the Director to
testify annually before Congress, and authorizes the Director
to provide additional reports to Congress. Testimony provided
by the Director is not subject to review or approval by any
other Federal agency or officer.
Section 154. Organizational structure; responsibilities of primary
programmatic units
This section establishes within the Office, to carry out
the programmatic responsibilities of the Office, the Data
Center and the Research and Analysis Center. The Data Center
shall, on behalf of the Council, collect, validate, and
maintain all data necessary to carry out the duties of the Data
Center. The data assembled shall be obtained from member
agencies of the Council, commercial data providers, publicly
available data sources, and financial entities. The Data Center
shall prepare and publish a financial company reference
database, financial instrument reference database, and formats
and standards for Office data, but shall not publish any
confidential data. The Research and Analysis Center shall, on
behalf of the Council, develop and maintain independent
analytical capabilities and computing resources to (1) develop
and maintain metrics and reporting systems for risks to the
financial stability of the United States, (2) monitor,
investigate, and report on changes in system-wide risk levels
and patterns to the Council and Congress, (3) conduct,
coordinate, and sponsor research to support and improve
regulation of financial entities and markets, (4) evaluate and
report on stress tests or other stability-related evaluations
of financial entities overseen by the member agencies, (5)
maintain expertise in such areas as may be necessary to support
specific requests for advice and assistance from financial
regulators, (6) investigate disruptions and failures in the
financial markets, report findings, and make recommendations to
the Council based on those findings, (7) conduct studies and
provide advice on the impact of policies related to systemic
risk, and (8) promote best practices for financial risk
management. Not later than 2 years after the date of enactment
of this Act, and not later than 120 days after the end of each
fiscal year thereafter, the Office shall submit a report to
Congress that assesses the state of the United States financial
system, including an analysis of any threats to the financial
stability of the United States, the status of the efforts of
the Office in meeting the mission of the Office, and key
findings from the research and analysis of the financial system
by the Office.
Section 155. Funding
This section provides authority to fund the Office through
assessments on nonbank financial companies supervised by the
Board of Governors pursuant to a determination under section
113 and bank holding companies with total consolidated assets
of $50 billion or more. The Board of Governors shall provide
interim funding during the 2-year period following the date of
enactment of this Act, and subsequent to the 2-year period the
Secretary of Treasury shall establish by regulation, with the
approval of the Council, an assessment schedule applicable to
such companies that takes into account differences among such
companies based on considerations for establishing the
prudential standards for such companies under section 115.
Section 156. Transition oversight
The purpose of this section is to ensure that the Office
has an orderly and organized startup, attracts and retains a
qualified workforce, and establishes comprehensive employee
training and benefits programs. The Office shall submit an
annual report to the Senate Banking Committee and the House
Financial Services Committee that includes a training and
workforce development plan, workplace flexibilities plan, and
recruitment and retention plan. The reporting requirement shall
terminate 5 years after the date of enactment of the Act.
Nothing in this section shall be construed to affect a
collective bargaining agreement or the rights of employees
under chapter 71 of title 5, United States Code.
Subtitle C--Additional Board of Governors Authority for Certain Nonbank
Financial Companies and Bank Holding Companies
Section 161. Reports by and examination of nonbank financial companies
by the Board of Governors
The Board of Governors may require reports from nonbank
financial companies supervised by the Board of Governors
pursuant to a determination under section 113 and any
subsidiaries of such companies, and may examine them to
determine the nature of the operations and financial condition
of the company and its subsidiaries; the financial,
operational, and other risks within the company that may pose a
threat to the safety and soundness of the company or the
stability of the U.S. financial system; the systems for
monitoring and controlling such risks; and compliance with the
requirements of this subtitle.
To the fullest extent possible, the Board of Governors
shall rely on reports and information that such companies and
their subsidiaries have provided to other Federal and State
regulatory agencies, and on reports of examination of
functionally regulated subsidiaries made by their primary
regulators (or in case of foreign nonbank financial companies,
reports provided to home country supervisor to the extent
appropriate).
Section 162. Enforcement
Nonbank financial companies supervised by the Board of
Governors will be subject to the enforcement provisions under
section 8 of the Federal Deposit Insurance Act.
If the Board of Governors determines that a depository
institution or functionally regulated subsidiary does not
comply with the regulations of the Board of Governors or
otherwise poses a threat to the financial stability of the
U.S., the Board of Governors may recommend in writing to the
primary financial regulatory agency for the subsidiary that the
agency initiate a supervisory action or an enforcement
proceeding. If the agency does not initiate an action within 60
days, the Board of Governors may take the recommended
supervisory or enforcement action.
Section 163. Acquisitions
A nonbank financial company supervised by the Board of
Governors pursuant to a determination under section 113 shall
be treated as a bank holding company for purposes of section 3
of the Bank Holding Company Act which governs bank
acquisitions. A nonbank financial company supervised by the
Board of Governors or a bank holding company with total
consolidated assets of $50 billion or more shall not acquire
direct or indirect ownership or control of any voting shares of
a company engaged in nonbanking activities having total
consolidated assets of $10 billion or more without providing
advanced written notice to the Board of Governors.
In addition to other criteria under the Bank Holding
Company Act for reviewing acquisitions, the Board of Governors
shall consider the extent to which a proposed acquisition would
result in greater or more concentrated risks to global or U.S.
financial stability of the global or U.S. economy.
Section 164. Prohibition against management interlocks between certain
financial holding companies
A nonbank financial company supervised by the Board of
Governors pursuant to a determination under section 113 shall
be treated as a bank holding company for purposes of the
Depository Institutions Management Interlocks Act. It is not
intended that a registered investment company sponsored by a
nonbank financial company be deemed unaffiliated with its
sponsor for the purpose of this section.
Section 165. Enhanced supervision and prudential standards for nonbank
financial companies supervised by the Board of Governors and
certain bank holding companies
This section directs the Board of Governors to establish
prudential standards and reporting and disclosure requirements
for nonbank financial companies supervised by the Board of
Governors pursuant to a determination under section 113 and
large, interconnected bank holding companies with total
consolidated assets of $50 billion or more. The standards and
requirements shall be more stringent than those applicable to
other nonbank financial companies and bank holding companies
that do not present similar risks to the financial stability of
the United States, and increase in stringency as appropriate in
relation to certain characteristics of the company, including
its size and complexity. The Board of Governors may adopt an
asset threshold greater than $50 billion for the applicability
of any particular standard. The prudential standards will
include risk-based capital requirements, leverage limits,
liquidity requirements, a contingent capital requirement,
resolution plan and credit exposure report requirements,
concentration limits, enhanced public disclosures, and overall
risk management requirements. The section enumerates the
factors that the Board of Governors shall consider in setting
the standards, which include those factors considered in
determining whether a nonbank financial company should be
subject to supervision and prudential standards by the Board of
Governors under section 113, among them the amounts and types
of assets and liabilities, degree of leverage, and extent of
off-balance sheet exposures. It requires that each nonbank
financial company supervised by the Board of Governors as well
as bank holding company with total consolidated assets of $10
billion or more that is a publicly traded company to establish
a risk committee to be responsible for oversight of enterprise-
wide risk management practices of the company.
With respect to the resolution plan requirement authorized
in this section, if the Board of Governors and the FDIC jointly
determine that the resolution plan of a company is not credible
and would not facilitate an orderly resolution under the
bankruptcy code, such company would have to resubmit resolution
plans to correct deficiencies. Failure to resubmit a plan
correcting deficiencies within a certain timeframe would result
in the imposition of more stringent capital, leverage, or
liquidity requirements, or restrictions on the growth,
activities, or operations of the company. If, two years after
the imposition of these requirements or restrictions, the
company still has not resubmitted a plan that corrects the
deficiencies, the Board of Governors and the FDIC, in
consultation with the Council, may direct the company to divest
certain assets or operations in order to facilitate an orderly
resolution under the bankruptcy code in the event of failure.
Section 166. Early remediation requirements
The Board of Governors, in consultation with the Council
and the FDIC, shall by regulation establish requirements to
provide for early remediation of financial distress of a
nonbank financial company supervised by the Board of Governors
pursuant to a determination under section 113 or a large,
interconnected bank holding company with total consolidated
assets of $50 billion or more. This provision does not
authorize the provision of any financial assistance from the
Federal government. Instead, the purpose of this provision is
to establish a series of specific remedial actions to be taken
by such company if it is experiencing financial distress, in
order to minimize the probability that the company will become
insolvent and the potential harm of such insolvency to the
financial stability of the United States. It is intended that
the requirements established under this section take into
account the structure and operations of, and any existing
regulatory regime applicable to, different types of nonbank
financial companies, including whether certain structures
impose legal or structural limits on the ability of the nonbank
financial company to hold capital.
Section 167. Affiliation
Nothing in this subtitle shall be construed to require a
nonbank financial company supervised by the Board of Governors
pursuant to a determination under section 113 or a company that
controls such nonbank financial company to conform it's
activities to the requirements of section 4 of the Bank Holding
Company Act. If such company engages in activities that are not
financial in nature, the Board of Governors may require such
company to establish and conduct its financial activities in an
intermediate holding company.
Section 168. Regulations
Except as otherwise specified in this subtitle, the Board
of Governors shall issue final regulations to implement this
subtitle no later than 18 months after the transfer date.
Section 169. Avoiding duplication
The Board of Governors shall take any action it deems
appropriate to avoid imposing requirements that are duplicative
of applicable requirements under other provisions of law.
Section 170. Safe harbor
The Board of Governors shall promulgate regulations on
behalf of, and in consultation with, the Council setting forth
the criteria for exempting certain types or classes of nonbank
financial companies from supervision by the Board of Governors
pursuant to a determination under section 113. It is intended
that such regulations take into account potential duplication
between the requirements under this title and Title VIII of
this Act for financial market utilities. The Board of
Governors, in consultation with the Council, shall review such
regulations no less frequently than every 5 years, and based
upon the review, the Board of Governors may update such
regulations, and such updates will not take effect until 2
years after publication in final form. The Chairpersons of the
Board of Governors and the Council shall submit a joint report
to the Senate Banking Committee and the House Financial
Services Committee not later than 30 days after issuing the
regulations or updates, and such report shall include at a
minimum the rationale for exemption and empirical evidence to
support the criteria for exemption.
Title II--Orderly Liquidation Authority
Section 201. Definitions
This section defines various terms used in this title.
Financial companies are defined as (1) bank holding companies,
(2) nonbank financial companies supervised by the Board of
Governors of the Federal Reserve System (Board of Governors)
pursuant to a determination under section 113 of this Act, (3)
other companies predominantly engaged in activities that the
Board of Governors has determined are financial in nature, or
incidental to activities that are financial in nature, for
purposes of section 4(k) of the Bank Holding Company Act of
1956, and (4) subsidiaries of any of the companies included in
(1), (2), and (3) other than an insured depository institution
or insurance company (but it is not intended that an investment
company required to be registered under the Investment Company
Act of 1940 would be deemed to be a subsidiary of a company
included in (1) (2), and (3) by reason of the provision by such
company of services to the investment company, unless such
company (including through all of its affiliates) owns 25
percent or more of the shares of the investment company). An
``insurance company'' is any entity that is engaged in the
business of insurance, subject to regulation by a State
insurance regulator, and covered by a State law that is
designed to specifically deal with the rehabilitation,
liquidation, or insolvency of an insurance company. A mutual
insurance holding company organized and operating under State
insurance laws may be considered an insurance company for the
purpose of this title. A ``covered financial company'' is a
financial company for which a determination has been made to
use the orderly liquidation authority under section 203.A
``covered broker or dealer'' is a covered financial company
that is a broker dealer registered with the Securities and
Exchange Commission (``SEC'') under section 15(b) of the
Securities Exchange Act of 1934 and is a member of Securities
Investor Protection Corporation (``SIPC'').
Section 202. Orderly Liquidation Authority Panel
This section establishes an Orderly Liquidation Authority
Panel (``Panel'') composed of 3 judges from the United States
Bankruptcy Court for the District of Delaware. Subsequent to a
determination by the Secretary of the Treasury (``Secretary'')
under section 203, the Secretary, upon notice to the Federal
Deposit Insurance Corporation (``FDIC'') and the covered
financial company, shall petition the Panel for an order
authorizing the Secretary to appoint the FDIC as receiver. The
Panel, after notice to the covered financial company and a
hearing in which the covered financial company may oppose the
petition, shall determine within 24 hours of receipt of the
petition whether the determination of the Secretary is
supported by substantial evidence. If the Panel determines that
the determination of the Secretary (1) is supported by
substantial evidence, the Panel shall issue an order
immediately authorizing the Secretary to appoint the
Corporation as receiver of the covered financial company, and
(2) is not supported by substantial evidence, the Panel shall
immediately provide the Secretary with a written statement of
its reasons and afford the Secretary with an opportunity to
amend and refile the petition with the Panel. The decision of
the Panel may be appealed to the United States Court of Appeals
not later than 30 days after the date on which the decision of
the Panel is rendered, and the decision of the Court of Appeals
may be appealed to the Supreme Court not later than 30 days
after the date of the final decision of the Court of Appeals.
This section also requires the following studies: a study
each by the Administrative Office of the United States Courts
and the Comptroller General of the United States regarding the
bankruptcy and orderly liquidation process for financial
companies under the Bankruptcy Code, and a study by the
Comptroller General of the United States regarding
international coordination relating to the orderly liquidation
of financial companies under the Bankruptcy Code.
Section 203. Systemic risk determination
This section establishes the process for triggering the use
of the orderly liquidation authority. The process includes
several steps intended to make the use of this authority very
rare. There is a strong presumption that the Bankruptcy Code
will continue to apply to most failing financial companies
(other than insured depository institutions and insurance
companies which have their own separate resolution processes),
including large financial companies.
To trigger the orderly liquidation authority, the Board of
Governors and the Board of Directors of the FDIC must each, by
a two-thirds vote of its members then serving, provide a
written recommendation to the Secretary that includes: (1) an
evaluation of whether a financial company is in default or in
danger of default; (2) a description of the effects that the
failure of the financial company would have on financial
stability in the United States; and (3) a recommendation
regarding the nature and extent of actions that should be taken
under this title. (The Secretary may request the Board of
Governors and the FDIC to consider making the recommendation,
or the Board of Governors and the FDIC may make the
recommendation on their own initiative.)
In the case of a covered broker or dealer, or in which the
largest U.S. subsidiary of a covered financial company is a
covered broker or dealer, the SEC and the Board of Governors
must each, by a two-thirds vote of its members then serving,
provide a written recommendation to the Secretary as described
above. (The Secretary of the Treasury may request the Board of
Governors and the SEC to consider making the recommendation, or
the Board of Governors and the SEC may make the recommendation
on their own initiative.)
Upon receiving such recommendations, the Secretary (in
consultation with the President) may make a written
determination that: (1) the financial company is in default or
in danger of default; (2) the failure of the financial company
and its resolution under otherwise applicable law would have
serious adverse effects on U.S. financial stability; (3) no
viable private sector alternative is available to prevent
default; (4) any effect on the claims or interests of
creditors, counterparties, and shareholders as a result of
actions taken under this title has been taken into account; (5)
any action under section 204 would avoid or mitigate such
adverse effects; and (6) a Federal regulatory agency has
ordered the financial company to convert all of its convertible
debt instruments that are subject to the regulatory order. The
Secretary would take into consideration the effectiveness of
the action in mitigating adverse effects on the financial
system, any cost to the Treasury, and the potential to increase
excessive risk taking on the part of creditors, counterparties,
and shareholders in the covered financial company.
The Secretary shall provide written notice of the
determination to Congress within 24 hours. The FDIC shall
submit a report to Congress within 60 days of its appointment
as receiver on the covered financial company and update the
information contained in the report at least quarterly. The
Government Accountability Office will review and report on the
Secretary's determination.
The FDIC shall establish policies and procedures acceptable
to the Secretary governing the use of funds available to the
FDIC to carry out this title.
If an insurance company that is a covered financial company
or subsidiary or affiliate of a covered financial company, its
liquidation or rehabilitation shall be conducted as provided
under state law. The FDIC shall have backup authority to file
appropriate judicial action in state court to place such a
company into liquidation under state law if the state regulator
fails to act within 60 days.
Section 204. Orderly liquidation
This section provides a strong presumption that, in the
exercise of orderly liquidation authority: (1) creditors and
shareholders will bear losses, (2) management responsible for
the company's financial condition are not retained, and (3) the
FDIC and other agencies (where applicable) take steps to ensure
that management and other parties responsible for the failed
company's financial condition bear losses through actions for
damages, restitution, and compensation clawbacks. The section
provides that the FDIC act as receiver of the covered financial
company upon appointment of the Corporation under section 202.
The FDIC, as receiver, must consult with primary financial
regulatory agencies of: (1) the covered financial company and
its covered subsidiaries to ensure an orderly liquidation; and
(2) any subsidiaries that are not covered subsidiaries to
coordinate the appropriate treatment of any such solvent
subsidiaries and the separate resolution of any such insolvent
subsidiaries under other governmental authority, as
appropriate. The FDIC shall consult with the SEC and the SIPC
in the case of a covered financial company that is a broker
dealer and member of SIPC. The FDIC may consult with or acquire
the services of outside experts to assist in the orderly
liquidation process.
The FDIC may make funds available to the receivership for
the orderly liquidation of the covered financial company
subject to the mandatory terms and conditions set forth in
section 206 and the orderly liquidation plan described in
section 210(n)(14).
Section 205. Orderly liquidation of covered brokers and dealers
This section authorizes the application of orderly
liquidation authority, if necessary, to a SIPC-member broker or
dealer while generally preserving SIPC's powers and duties
under the Securities Investor Protection Act of 1970 (``SIPA'')
with respect to the liquidation of such entity. The section
provides that the FDIC shall appoint SIPC, without any need for
court approval, to act as trustee for liquidation under the
SIPA of a covered broker or dealer. The subsection prescribes
the powers, duties, and limitation of powers of SIPC as
trustee. Except as otherwise provide in this title, no court
may take any action, including an action pursuant to the SIPA
or the Bankruptcy Code, to restrain or affect the powers or
functions of the FDIC as receiver of the covered broker or
dealer.
Section 206. Mandatory terms and conditions for all orderly liquidation
actions
The FDIC shall take action under this title only if it
determines that such actions are necessary for financial
stability and not for the purpose of preserving the covered
financial company. The FDIC must also ensure that shareholders
would not receive any payment until after all other claims are
fully paid, that unsecured creditors bear losses in accordance
with the claims priority provisions in section 210, and that
management responsible for the company's failure is removed (if
it has not already been removed at the time of the FDIC's
appointment as receiver).
Section 207. Directors not liable for acquiescing in appointment of
receiver
This section exempts the board of directors of a covered
financial company from liability to the company's shareholders
or creditors for acquiescing or consenting in good faith to
appointment of a receiver under section 202.
Section 208. Dismissal and exclusion of other actions
This section provides that the appointment of the FDIC as
receiver under section 202 for a covered financial company or
the appointment of SIPC as trustee for a covered broker or
dealer under section 205 shall result in the dismissal of any
existing bankruptcy or insolvency case or proceeding and
prevent the commencement of any such case or proceeding while
the orderly liquidation is pending.
Section 209. Rulemaking; non-conflicting law
This section requires the FDIC, in consultation with the
Council, to prescribe such rules or regulations as considered
necessary or appropriate to implement this title. To the extent
possible, the FDIC shall seek to harmonize applicable rules and
regulations promulgated under this section with the insolvency
laws that would otherwise apply to a covered financial company.
Section 210. Powers and duties of the corporation
Subsection (a). Powers and authorities
This subsection defines the powers and authorities of the
FDIC as receiver of a covered financial company, including its
powers and duties: (1) to succeed to the rights, title, powers,
and privileges of the covered financial company and its
stockholders, members, officers, and directors; (2) to operate
the company with all the powers of shareholders, members,
directors, and officers; (3) to liquidate the company through
sale of assets or transfer of assets to a bridge financial
company established under subsection (h); (4) to merge the
company with another company or transferring assets or
liabilities; (5) to pay valid obligations that come due, to the
extent that funds are available; (6) to exercise subpoena
powers; (7) to utilize private sector services to manage and
dispose of assets; (8) to terminate rights and claims of
stockholders and creditors (except for the right to payment of
claims consistent with the priority of claims provision under
this section); and (9) to determine and pay claims. The
subsection also prescribes the FDIC's authorities to avoid
fraudulent or preferential transfers of interests of the
covered financial company.
Subsection (b). Priority of expenses and unsecured claims
This section defines the priority of expenses and unsecured
claims against the covered financial company or the FDIC as
receiver for such company. All claimants of a covered financial
company that are similarly situated in the expenses and claims
priority shall be treated in a similar manner except in cases
where the FDIC determines that doing otherwise would maximize
the value of the company's assets or maximize the present value
of the proceeds (or minimize the amount of any loss) from
disposing of the assets of the company. Creditors who receive
more than they would otherwise receive if all similarly
situated creditors were treated in a similar manner would be
subject to a substantially higher assessment rate under
subsection (o)(1)(E)(ii). All claimants that are similarly
situated in the expenses and claims priority shall not receive
less than the maximum liability amount defined in subsection
(d). The section also defines the priority of expenses and
unsecured claims in those cases where the FDIC is appointed
receiver for a covered broker or dealer.
Subsection (c). Provisions relating to contracts entered
into before appointment of receiver
This subsection authorizes the FDIC to repudiate and
enforce contracts and handle the financial company's qualified
financial contracts (including derivatives). A counterparty to
a qualified financial contract would be stayed from
terminating, liquidating, or netting the contract (solely by
reason of the appointment of a receiver) until 5:00 PM on the
fifth business day after the date that the FDIC was appointed
receiver. (The length of the stay differs from that authorized
under the Federal Deposit Insurance Act with respect to an
insured depository institution. Under the Federal Deposit
Insurance Act, the stay would last until 5:00 PM one business
day following the date that the FDIC was appointed receiver.)
Subsection (d). Valuation of claims in default
This subsection establishes the FDIC's maximum liability
for claims against the covered financial company (or FDIC as
receiver) as the amount that the claimant would have received
if the FDIC had not been appointed receiver with respect to the
covered financial company and the company was liquidated under
chapter 7 of the U.S. Bankruptcy Code or any State insolvency
law. The subsection also authorizes the FDIC, as receiver and
with the Secretary's approval, to make additional payments to
claimants only if the FDIC determines this to be necessary to
minimize losses to the FDIC as receiver from the orderly
liquidation of the covered financial company. Creditors who
receive such additional payments would be subject to a
substantially higher assessment rate under subsection
(o)(1)(E)(ii).
Subsection (e). Limitation on court action
This subsection precludes a court from taking action to
restrain or affect the powers or functions of the FDIC when it
is exercising its powers as receiver, except as otherwise
provided in the title.
Subsection (f). Liability of directors and officers
This subsection provides that FDIC may take actions to hold
directors and officers of a covered financial company
personally liable for monetary damages with respect to gross
negligence.
Subsection (g). Damages
This subsection provides that recoverable damages in claims
brought against directors, officers, or employees of a covered
financial company for improper investment or use of company
assets include principal losses and appropriate interest.
Subsection (h). Bridge financial companies
This subsection authorizes the FDIC, as receiver, to
establish one or more bridge financial companies. Such bridge
financial companies may assume liabilities and purchase assets
of the covered financial company, and perform other temporary
functions that the FDIC may prescribe.
Subsection (i). Sharing records
This subsection requires other Federal regulators to make
available to the FDIC all records relating to the covered
financial company.
Subsection (j). Expedited procedures for certain claims
This subsection expedites federal courts' consideration of
cases brought by the FDIC against a covered financial company's
directors, officers, employees, or agents.
Subsection (k). Foreign investigations
This subsection authorizes the FDIC, as receiver, to
request assistance from, and provide assistance to, any foreign
financial authority.
Subsection (l). Prohibition on entering secrecy agreements
and protective orders
This subsection prohibits the FDIC from entering into any
agreement that prohibits it from disclosing the terms of any
settlement of any action brought by the FDIC as receiver of a
covered financial company.
Subsection (m). Liquidation of certain covered financial
companies or bridge financial companies
This subsection provides that the FDIC, as receiver, in
liquidating any covered financial company or bridge financial
company that is either (1) a stockbroker that is not a member
of SIPC, or (2) a commodity broker, will apply the applicable
liquidation provisions of the bankruptcy code pertaining to
``stockbrokers'' and ``commodity brokers'' (as such terms are
defined in subchapters III and IV, respectively, of chapter 7
of chapter 7 of the U.S. Bankruptcy Code).
Subsection (n). Orderly Liquidation Fund
This subsection creates the Orderly Liquidation Fund
(``Fund') in the Treasury Department that will be available to
the FDIC to carry out the authorities in this title. The sole
purpose of the Fund is to allow the FDIC to carry out the
orderly liquidation of a covered financial company as
authorized by this title; the Fund may not be used for any
other purpose. The FDIC shall manage the Fund consistent with
the policies and procedures acceptable to the Secretary of
Treasury that are established under section 203(d), and invest
amounts held in the Fund that are not required to meet the
FDIC's current needs in obligations of the United States.
The target size of the Fund shall be $50 billion, adjusted
on a periodic basis for inflation. The FDIC shall impose
assessments as provided in subsection (o) to capitalize the
Fund and reach the target size during an ``initial
capitalization period'' of not less than 5 years or greater
than 10 years from the date of enactment. (The FDIC, with the
approval of the Secretary of the Treasury, may extend the
initial capitalization period if the Fund incurs a loss from
the failure of a covered financial company before the initial
capitalization period expires.) Except as provided in
subsection (o), FDIC shall suspend assessments when the initial
capitalization period expires. The intention of this subsection
and subsection (o) is to require large financial firms, rather
than taxpayers, to serve as the first source of liquidity in
winding down the failed financial company.
The FDIC may issue obligations to the Secretary of the
Treasury. FDIC may not issue or incur any obligation that would
result in total obligations outstanding that exceed the sum of
(1) the amount of cash and cash equivalents held in the Fund,
and (2) the amount that is equal to 90 percent of the fair
value of assets from each covered financial company that are
available to repay the FDIC (the ``maximum obligation
limitation''). It is intended that the determination of the
amount available to the FDIC under (2) above be limited to what
the assets of the covered financial company, calculated on a
consolidated basis, can support. The FDIC and the Secretary
shall jointly prescribe rules, in consultation with the
Council, governing the calculation of the maximum obligation
limitation.
The FDIC may issue obligations only after the cash and cash
equivalents of the Fund have been drawn down to facilitate the
orderly liquidation of a covered financial company.
Amounts in the Fund shall be available to the FDIC with
regard to a covered financial company for which the FDIC has
been appointed receiver after the FDIC has developed an orderly
liquidation plan acceptable to the Secretary of the Treasury.
The FDIC may amend an approved plan at any time, with the
concurrence of the Secretary.
Subsection (o). Risk-based assessments
This subsection requires the FDIC to charge risk-based
assessments to eligible financial companies during the initial
capitalization period until the FDIC determines that the Fund
has reached the target size. Eligible financial companies
include bank holding companies with total consolidated assets
equal to or greater than $50 billion and nonbank financial
companies supervised by the Board of Governors pursuant to a
determination under section 113 of Title I.
The FDIC must charge additional risk-based assessments if:
(1) the Fund falls below the target size after the initial
capitalization period in order to restore the Fund to the
target size over a period determined by the FDIC; (2) the FDIC
is appointed receiver for a covered financial company and the
Fund incurs a loss during the initial capitalization period; or
(3) such assessments are necessary to pay in full obligations
issued to the Secretary of the Treasury within 60 months of
their issuance (unless the FDIC requests, and the Secretary
approves, an extension in order to avoid as serious adverse
effect on the U.S. financial system). If required, any such
additional risk-based assessments shall be imposed on (1)
eligible financial companies and financial companies with total
assets equal to or greater than $50 billion that are not
eligible financial companies, and (2) any financial company, at
a substantially higher rate than would otherwise be assessed,
that benefitted from the orderly liquidation under this title
by receiving payments or credit pursuant to subsections (b)(4),
(d)(4), and (h)(5). The subsection outlines the risk factors
that the FDIC shall consider in imposing risk-based assessments
to capitalize the Fund as well as any additional assessments
that may be required.
The FDIC shall prescribe regulations to carry out this
subsection in consultation with the Secretary and the Council,
and such regulations shall take into account the differences in
risks posed by different financial companies, the differences
in the liability structure of financial companies, and the
different bases for other assessments that such financial
companies may be required to pay, to ensure that assessed
financial companies are treated equitably and that assessments
under this subsection reflect such differences. It is intended
that the risk-based assessments may vary among different types
or classes of financial companies in accordance with the risks
posed to the financial stability of the United States. For
instance, certain types of financial companies such as
insurance companies and other financial companies that may
present lower risk to U.S. financial stability (as indicated,
for example, by higher capital, lower leverage, or similar
measures of risk as appropriate depending on the nature of the
business of the financial companies) relative to other types of
financial companies should be assessed at a lower rate.
Furthermore, the FDIC should consider the impact of potential
assessment on the ability of certain tax-exempt entities to
carry out their legally required charitable and educational
missions, such as the ability of not-for-profit fraternal
benefit societies to carry out their state and federally
required missions to serve their members and communities.
Subsection (p). Unenforceability of certain agreements
This subsection prohibits enforceability of any term
contained in any existing or future standstill,
confidentiality, or other agreement that affects or restricts
the ability of a person to acquire, that prohibits a person
from offering to acquire, or that prohibits a person from using
previously disclosed information in connection with an offer to
acquire, all or part of a covered financial company.
Subsection (q). Other exemptions
This subsection provides certain exemptions to the FDIC
from taxes and levies when acting as a receiver for a covered
financial company.
Subsection (r). Certain sales of assets prohibited
This subsection requires the FDIC to prescribe regulations
prohibiting the sale of assets of a covered financial company
to certain persons found to have been engaged in fraudulent
activity or participated in transactions causing substantial
losses to a covered financial company or who are convicted
debtors.
Section 211. Miscellaneous provisions
This section makes a conforming change relating to
concealment of assets from the FDIC acting as receiver for a
covered financial company, and makes a conforming change to the
netting provisions contained in the Federal Deposit Insurance
Corporation Improvement Act of 1991 by expanding the exceptions
to include section 210(c) of this Act and section 1367 of HERA
(12 U.S.C. 4617(d)).
Title III--Transfer of Powers to the Comptroller of the Currency, the
Corporation, and the Board of Governors
Section 301. Short title and purposes
The short title is ``Enhancing Financial Institution Safety
and Soundness Act of 2010.'' Among the purposes of the title
are to provide for the safe and sound operation of the banking
system; to preserve and protect the dual banking system of
federal and state chartered depository institutions; and to
streamline and rationalize the supervision of depository
institutions and their holding companies.
Section 302. Definitions
Defines the term ``transferred employee'' to refer to those
employees who are transferred from the Office of Thrift
Supervision (``OTS'') to the Office of the Comptroller of the
Currency (``OCC'') or the Federal Deposit Insurance Corporation
(``FDIC'').
Subtitle A--Transfer of Powers and Duties
Section 311. Transfer date
The ``transfer date'' is the date that is 1 year after the
date of enactment or another date not later than 18 months if
so designated by the Secretary of the Treasury. The transfer
date is the date upon which various functions are transferred
from the OTS to the Federal Reserve Board (``Board''), the OCC,
and the FDIC. Additionally, certain functions of the Board are
transferred to the OCC and FDIC. The transfer of personnel,
property and funding are also keyed to the transfer date.
Section 312. Powers and duties transferred
This section transfers all functions of the OTS to the
Board, the OCC, and the FDIC. It also transfers from the Board
to the OCC and the FDIC, supervisory authority over the holding
companies of smaller banks. And, it transfers from the Board to
the FDIC, the supervision of insured state member banks.
As a result of these various transfers, the Board will
regulate the larger, more complex bank and thrift holding
companies--i.e., those with total consolidated assets of $50
billion or more. The OCC will retain its authority over all
national banks regardless of their size and will also supervise
federal thrifts. The OCC will become a holding company
regulator for the smaller bank and thrift holding companies
(under $50 billion) where the majority of depository
institution assets are in national banks or federal thrifts.
The FDIC will regulate all insured state banks regardless of
their size--including those that are members of the Federal
Reserve System--and all state savings associations. The FDIC
will also supervise the smaller holding companies (under $50
billion) where the majority of depository institution assets
are in insured state banks or state thrifts.
The Board will retain its authority to issue rules under
the Bank Holding Company Act and will also have the authority
to issue rules under the Home Owners Loan Act with respect to
savings and loan holding companies. When issuing rules under
these acts that apply to bank and thrift holding companies with
less than $50 billion in assets, the Board must consult with
the OCC and the FDIC. The OCC and FDIC will jointly write the
rules that apply to thrifts.
This section amends the definition of ``appropriate federal
banking agency'' in section 3(q) of the Federal Deposit
Insurance Act which indicates the allocation of regulatory
responsibility among the federal banking agencies by type of
company--such as a national bank, a state member bank, a
federal savings association. The definition is amended to
reflect the new responsibilities of the Board, FDIC, and OCC.
In addition to the description above, the Board will maintain
its supervision of uninsured state member banks and various
foreign bank-related entities.
This section also requires the OCC, Board and FDIC to issue
a joint regulation specifying how the $50 billion will be
calculated and at what frequency to determine the appropriate
holding company regulator. In terms of the frequency of the
assessment, it can be no less than 2 years, unless with respect
to a particular institution there is a transaction outside the
ordinary course of business, such as a merger or acquisition.
In issuing the regulations, the agencies are directed to avoid
disruptive transfers of regulatory authority.
Section 313. Abolishment
This section abolishes the OTS.
Section 314. Amendments to the revised statutes
This section clarifies the mission and authorities of the
OCC.
Section 315. Federal information policy
This section clarifies that the OCC is an independent
agency for purposes of Federal information policy.
Section 316. Savings provisions
This section preserves the existing rights, duties and
obligations of the OTS, the Board, and the Federal Reserve
banks that existed on the day before the transfer date. This
section also preserves existing law suits by or against the
OTS, the Board, and the Federal Reserve banks, but states that
as of the transfer date, law suits against the OTS in
connection with functions transferred to the OCC, the FDIC, or
Board, are transferred to these agencies as appropriate. In
addition, as of the transfer date, law suits against the Board
or a Federal Reserve bank in connection with functions
transferred to the OCC or the FDIC are transferred to these
agencies as appropriate.
This section also continues all of the existing orders,
regulations, determinations, agreements, procedures,
interpretations and advisory materials of the OTS and those of
the Board that relate to the Board's functions that have been
transferred.
Section 317. References in Federal law to Federal banking agencies
This section provides that references in Federal law to the
OTS with respect to functions that are transferred shall be
deemed references to the OCC, FDIC, or Board, as appropriate.
In addition, references in Federal law to the Board and the
Federal Reserve banks with respect to their functions that are
transferred shall be deemed references to the OCC or the FDIC,
as appropriate.
Section 318. Funding
This section allows the Comptroller to collect an
assessment, fee, or other charge from any entity the OCC
supervises as necessary to carry out its responsibilities
including with respect to holding companies, federal thrifts,
and nonbank affiliates (that are not functionally regulated)
that engage in bank permissible activities. The OCC's
supervision of these nonbank affiliates is provided under a new
section 6 of the Bank Holding Company Act of 1956 which is
added in Title VI of this Act. In establishing the amount of an
assessment, fee, or other charge collected from an entity, the
OCC may take into account the funds transferred to the OCC
(under a new arrangement with the FDIC), the nature and scope
of the activities of the entity, the amount and types of assets
held by the entity, the financial and managerial condition of
the entity, and any other factor that the OCC deems
appropriate.
This section also authorizes the FDIC to charge for its
supervision of nonbank affiliates under new section 6 of the
Bank Holding Company Act.
This section requires the OCC to submit to the FDIC a
proposal to promote parity in the examination fees state and
federal depository institutions having total consolidated
assets of less than $50,000,000,000 pay for their supervision.
Currently, the FDIC and the Board do not charge state banks
for their federal supervision. (These agencies share
examination responsibilities with the states, and thus lower
the costs to the states of supervising these entities. While
the states charge for supervision, the FDIC and Board do not.)
The FDIC pays for supervision of state banks from the Deposit
Insurance Fund (DIF). Both state and federal depository
institutions pay insurance premiums into the DIF. Thus,
national banks and federal thrifts help defray the costs
associated with the FDIC's supervision of state nonmember
banks. This subsidy will only grow when the FDIC assumes the
supervision of all state banks and state thrifts, as well as
most of their holding companies, if the FDIC continues to rely
on the DIF to fund supervision.
The funding disparity can also exacerbate regulatory
arbitrage according to testimony the Committee received. The
OCC must assess its banks for examination fees whereas the FDIC
and the Board have other means to fund their supervision of
state banks. [footnote to Ludwig's testimony, September 29,
2009] Thus promoting parity in examination fees should reduce
the arbitrage in the system and the subsidy for federal
supervision of state banks by national banks and federal
thrifts.
Under this section, the OCC's proposal will recommend a
transfer from the FDIC to the OCC of a percentage of the amount
that the OCC estimates is necessary or appropriate to carry out
its supervisory responsibilities of federal depository
institutions having total consolidated assets of less than
$50,000,000,000. The FDIC is directed to assist the OCC in
collecting data relative to the supervision of State depository
institutions to develop the proposal.
Not later than 60 days after receipt of the proposal, the
FDIC Board must vote on the proposal and promptly implement a
plan to periodically transfer to the OCC a percentage of the
amount that the OCC estimates is necessary or appropriate to
carry out the its supervisory responsibilities for national
banks and federal thrifts having total consolidated assets of
less than $50,000,000,000, as approved by the FDIC Board. Not
later than 30 days after the FDIC Board's vote, the FDIC must
submit to the Senate Banking Committee and House Financial
Services Committee a report describing the OCC's proposal and
the decision resulting from the FDIC Board's vote. If, by 2
years after the date of enactment of this Act, the FDIC Board
has failed to approve a plan, the Financial Stability Oversight
Council shall approve a plan using the dispute resolution
procedures under section 119.
The section also requires the Board to collect assessments,
fees, and charges from (1) bank holding companies and savings
and loan holding companies that have total consolidated assets
equal to or greater than $50 billion, and (2) all nonbank
financial companies supervised by the Board under section 113
of this Act, that are equal to the total expenses incurred by
the Board to carry out its responsibilities with respect to
such companies. Charging holding companies for the Board's
supervision will result in savings by the taxpayer.
Section 319. Contracting and leasing authority
This section clarifies the contracting and leasing
authorities of the Office of the Comptroller of the Currency.
Subtitle B--Transitional Provisions
Section 321. Interim use of funds, personnel, and property
This section provides for the orderly transfer of functions
(1) from the OTS to the OCC, FDIC and the Board; and (2) from
the Board to the OCC and FDIC, with specific reference to
funds, personnel and property.
Section 322. Transfer of employees
This section states that all employees of the OTS are
transferred to OCC or the FDIC. The OTS, OCC and FDIC must
jointly identify the employees necessary to carry out the
duties transferred from the OTS to the OCC and the FDIC. The
Board, OCC and FDIC must jointly identify the employees
necessary to carry out the duties transferred from the Board
(including the Federal Reserve banks) to the OCC or the FDIC.
Under this section, relevant employees are transferred
within 90 days of the transfer date. The section also describes
the extent to which employees' status, tenure, pay, retirement
and health care benefits are protected, and describes employee
protections from involuntary separation and reassignments
outside locality pay area. It also provides that not later than
2 years from the transfer date, the OCC and FDIC must each
place the transferred employees into the established pay and
classification systems of the OCC and FDIC. In addition, this
section provides that the OCC and FDIC may not take any action
that would unfairly disadvantage a transferred employee
relative to other OCC and FDIC employees on the basis of their
prior employment by the OTS.
Section 323. Property transferred
This section provides that property of the OTS is
transferred to the OCC and FDIC. The OCC, FDIC and Board, will
jointly determine which property of the Board should be
transferred and to which of the agencies.
Section 324. Funds transferred
This section provides that except to the extent necessary
to dispose of the affairs of the OTS, all funds available to
the OTS are transferred to the OCC, FDIC, or Board, in a manner
commensurate with the functions that are transferred to these
agencies.
Section 325. Disposition of affairs
This section describes the authority of the Director of the
OTS and the Chairman of the Board during the 90 day period
beginning on the transfer date, to manage employees and
property that have not yet been transferred, and to take
actions necessary to wind up matters relating to any function
transferred to another agency.
Section 326. Continuation of services
This section states that any agency, department or
instrumentality of the U.S. that was providing support services
to the OTS or the Board, in connection with functions
transferred to another agency, shall continue to provide such
services until the transfer of functions is complete, and
consult with the OCC, FDIC, or Board, as appropriate, to
coordinate and facilitate a prompt and orderly transition.
Subtitle C--Federal Deposit Insurance Corporation
Section 331. Deposit insurance reform
This section amends the Federal Deposit Insurance Act to
repeal the provision that states no institution may be denied
the lowest-risk category solely because of its size. This
section also directs the FDIC, unless it makes a written
determination discussed below, to amend its regulations to
define the term ``assessment base'' of an insured depository
institution for purposes of deposit insurance assessments as
the average total assets of the insured depository institution
during the assessment period, minus the sum of (1) the average
tangible equity of the insured depository institution during
the assessment period and (2) the average long-term unsecured
debt of the insured depository institution during the
assessment period.
If, not later than 1 year after the date of enactment of
this Act, the FDIC submits to the Senate Banking Committee and
House Financial Services Committee, in writing, a finding that
such an amendment to its regulations regarding the definition
of the term ``assessment base'' would reduce the effectiveness
of the FDIC's risk-based assessment system or increase the risk
of loss to the Deposit Insurance Fund, the FDIC may retain the
definition of the term ``assessment base'', as in effect on the
day before the date of enactment of this Act, or establish, by
rule, a definition of the term ``assessment base'' that the
FDIC deems appropriate.
There is concern that the new assessment base will create
an additional burden on insured depository institutions that
support asset growth through increased reliance on Federal Home
Loan Bank advances. Based on its current risk-based assessment
rate regulations, the FDIC imposes an upward adjustment on an
institution's deposit insurance assessment rate if the
institution has secured liabilities, including Federal Home
Loan Bank advances, in excess of a certain threshold. This
section would now direct the FDIC to include assets funded by
secured liabilities (including Federal Home Loan Bank advances)
in an institution's assessment base. Therefore, the Committee
recommends that the FDIC also review and adjust its risk-based
assessment rate regulations, if warranted, to ensure that the
assessment appropriately reflects the risk posed by an insured
depository institution as a result of the changes to the
assessment base.
Section 332. Management of the Federal Deposit Insurance Corporation
This section replaces the position of the OTS on the FDIC
Board of Directors with the Director of the Consumer Financial
Protection Bureau.
Subtitle D--Termination of Federal Thrift Charter
Section 341. Termination of federal savings associations
This section provides that upon the date of enactment of
this Act, neither the Director of the OTS nor the OCC may issue
a charter for a federal savings association.\129\
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\129\``Congress created the federal thrift charter in the Home
Owners' Loan Act of 1933 in response to the extensive failures of
state-chartered thrifts and the collapse of the broader financial
system during the Great Depression. The rationale for federal thrifts
as a specialized class of depository institutions focused on
residential mortgage lending made sense at the time but the case for
such specialized institutions has weakened considerably in recent
years. Moreover, over the past few decades, the powers of thrifts and
banks have substantially converged.
As securitization markets for residential mortgages have grown,
commercial banks have increased their appetite for mortgage lending,
and the Federal Home Loan Bank System has expanded its membership base.
Accordingly, the need for a special class of mortgage-focused
depository institutions has fallen. Moreover, the fragility of thrifts
has become readily apparent during the financial crisis. In part
because thrifts are required by law to focus more of their lending on
residential mortgages, thrifts were more vulnerable to the housing
downturn that the United States has been experiencing since 2007. The
availability of the federal thrift charter has created opportunities
for private sector arbitrage of our financial regulatory system.''
``Financial Regulatory Reform: A New Foundation,'' Administration's
White Paper, introduced June 17, 2009.
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While this provision would not allow the establishment of
any new federal thrifts, it does not affect the state thrift
charter. Nor does it impose any new limits on existing federal
thrifts or their owners. It would not require the divestiture
of any thrift and it protects the status of existing unitary
thrift holding companies.
Section 342. Branching
This section states that a savings association that becomes
a bank may continue to operate its branches.
Title IV--Private Fund Investment Advisers Registration Act of 2010
Section 401. Short title
Section 401 provides the title of the Act as the ``Private
Fund Investment Advisers Registration Act of 2010''.
Section 402. Definitions
Section 402 defines the terms ``private fund'' and
``foreign private adviser.'' ``Private funds'' are issuers that
would be regulated investment companies, but for sections
3(c)(1) or 3(c)(7) of the Investment Company Act of 1940 (which
provide exemptions for issuers with fewer than 100 shareholders
or where all shareholders are qualified purchasers).
``Foreign private advisers'' are those that have no place
of business in the United States; do not hold themselves out
generally to the public in the United States as investment
advisers; and have fewer than 15 U.S. clients with less than
$25 million in assets under management.
Section 403. Elimination of private adviser exemption; limited
exemption for foreign private advisers; limited intrastate
exemption
Section 403 would require advisers to large hedge funds to
register with the SEC, making them subject to record keeping,
examination, and disclosure requirements. The rationale for the
provision is that the unregulated status of large hedge funds
constitutes a serious regulatory gap. No precise data regarding
the size and scope of hedge fund activities are available, but
the common estimate is that the funds had about $2 trillion
under management before the crisis, and that amount may be
magnified by leverage. They are significant participants in
many financial markets; their trades and strategies can affect
prices. While hedge funds are generally not thought to have
caused the current financial crisis, information regarding
their size, strategies, and positions could be crucial to
regulatory attempts to deal with a future crisis. The case of
Long-Term Capital Management, a hedge fund that was rescued
through Federal Reserve intervention in 1998 because of
concerns that it was ``too-interconnected-to-fail,'' indicates
that the activities of even a single hedge fund may have
systemic consequences.
Section 403 was included in the Treasury's Department's
regulatory reform proposal for hedge funds.\130\ Former SEC
Chairman Arthur Levitt wrote in testimony for the Senate
Banking Committee that he would ``recommend placing hedge funds
under SEC regulation in the context of their role as money
managers and investment advisers.''\131\ Advocates such as the
AFL-CIO\132\, CalPERS,\133\ and the Investment Adviser
Association\134\ also support placing hedge funds under SEC
regulation via the Investment Advisers Act of 1940. Expert
panels such as the Group of Thirty,\135\ the G-20,\136\ the
Investor's Working Group,\137\ and the Congressional Oversight
Panel\138\ also support this provision, as do industry groups
such as the Alternative Investment Management Association,\139\
the Private Equity Council,\140\ and the Coalition of Private
Investment Companies (CPIC). Mr. James Chanos, Chairman of the
CPIC, testified before the Committee that ``private funds (or
their advisers) should be required to register with the SEC. .
. . Registration will bring with it the ability of the SEC to
conduct examinations and bring administrative proceedings
against registered advisers, funds, and their personnel. The
SEC also will have the ability to bring civil enforcement
actions and to levy fines and penalties for violations.''\141\
Former SEC Chief Accountant Lynn Turner also supported this
provision in testimony.\142\
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\130\FACT SHEET: Administration's Regulatory Reform Agenda Moves
Forward; Legislation for the Registration of Hedge Funds Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 15,
2009, www.financialstability.gov.
\131\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.9
(2009) (Testimony of Mr. Arthur Levitt).
\132\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Damon Silvers).
\133\Regulating Hedge Funds and Other Private Investment Pools:
Testimony before the Subcommittee on Securities, Insurance, and
Investment of the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session (2009) (Testimony of Mr. Joseph
Dear).
\134\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. David Tittsworth).
\135\Financial Reform: A Framework for Financial Stability, Group
of Thirty, January 15, 2009.
\136\Enhancing Sound Regulation and Strengthening Transparency, G20
Working Group 1, March 25, 2009.
\137\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, July 2009.
\138\Special Report on Regulatory Reform, Congressional Oversight
Panel, January 2009.
\139\Alternative Investment Management Association (January 23,
2009) ``AIMA Supports US Regulatory Reform Proposals'', Press Release,
www.aima.org.
\140\Capital Markets Regulatory Reform: Strengthening Investor
Protection, Enhancing Oversight of Private Pools of Capital, and
Creating a National Insurance Office: Testimony before the U.S. House
Committee on Financial Services, 111th Congress, 1st session (2009)
(Testimony of Mr. Douglas Lowenstein).
\141\Regulating Hedge Funds and Other Private Investment Pools:
Testimony before the Subcommittee on Securities, Insurance, and
Investment of the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.17 (2009) (Testimony of Mr.
James Chanos).
\142\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Lynn Turner).
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A significant number of hedge funds are already registered
with the SEC, on a voluntary basis. Hedge Fund Research reports
that nearly 55 percent of the hedge fund firms located in the
United States are currently registered with the SEC, and that
SEC-registered hedge fund firms manage nearly 71 percent of all
US-based hedge fund capital.
Section 403 eliminates the exemption in section 203(b)(3)
of the Investment Advisers Act of 1940 for advisers with fewer
than 15 clients. Under current law, a hedge fund is counted as
a single client, allowing hedge fund advisers to escape the
obligation to register with the SEC. The Section adds an
exemption for foreign private advisers, as defined in this Act.
The Section adds a limited intrastate exemption, and an
exemption for Small Business Investment Companies licensed by
(or in the process of obtaining a license from) the Small
Business Administration.
Section 404. Collection of systemic risk data; reports; examinations;
disclosures
Section 404 authorizes the SEC to require advisers to
private funds to file specific reports, which the SEC shall
share with the Financial Stability Oversight Council. The
filings shall describe the amount of assets under management,
use of leverage, counterparty credit risk exposure, trading and
investment positions, valuation policies, types of assets held,
and other information that the SEC, in consultation with the
Council, determines is necessary and appropriate to protect
investors or assess systemic risk. Reporting requirements may
be tailored to the type or size of the private fund. Frequency
of reporting is at the SEC's discretion.
Paul Schott Stevens, President of the Investment Company
Institute, testified before the Committee that ``the Capital
Markets Regulator should require nonpublic reporting of
information, such as investment positions and strategies that
could bear on systemic risk and adversely impact other market
participants.''\143\ Richard Ketchum, Chairman of FINRA, said
``The absence of transparency about hedge funds and their
investment positions is a concern.''\144\ Hedge fund industry
groups also support this provision, including the Managed Funds
Association,\145\ the Coalition of Private Investment
Companies,\146\ and the Private Equity Council.\147\
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\143\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p.12 (2009)
(Testimony of Mr. Paul Schott Stevens).
\144\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.5
(2009) (Testimony of Mr. Richard Ketchum).
\145\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session,
(2009) (Testimony of Mr. Richard Baker).
\146\Regulating Hedge Funds and Other Private Investment Pools:
Testimony before the Subcommittee on Securities, Insurance, and
Investment of the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session (2009) (Testimony of Mr. James
Chanos).
\147\Capital Markets Regulatory Reform: Strengthening Investor
Protection, Enhancing Oversight of Private Pools of Capital, and
Creating a National Insurance Office: Testimony before the U.S. House
Committee on Financial Services, 111th Congress, 1st session (2009)
(Testimony of Mr. Douglas Lowenstein).
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Section 404 requires the SEC to make available to the
Financial Stability Oversight Council any private fund records
it receives that the Council considers necessary to assess the
systemic risk posed by a private fund. These records must be
kept confidential: the Council must observe the same standards
of confidentiality that apply to the SEC. Private fund records,
including those containing proprietary information, are not
subject to disclosure pursuant to the Freedom of Information
Act.
This section also directs the SEC to report annually to
Congress on how it has used information collected from private
funds to monitor markets for the protection of investors and
market integrity.
Section 405. Disclosure provision eliminated
Section 405 authorizes the SEC to require investment
advisers to disclose the identity, investments, or affairs of
any client, if necessary to assess potential systemic risk.
Section 406. Clarification of rulemaking authority
Section 406 clarifies the SEC's authority to define
technical, trade, and other terms used in the title, except
that the SEC may not define ``client'' to mean investors in a
fund, rather than the fund itself, for purposes of Section 206
(1) and (2) of the Advisers Act, which governs fraud. The
clarification avoids potential conflicts between the fiduciary
duty an adviser owes to a private fund and to the individual
investors in the fund (if those investors are defined as
clients of the adviser). Actions in the best interest of the
fund may not always be in the best interests of each individual
investor. The section also directs the SEC and CFTC to jointly
promulgate rules regarding the form and content of reporting by
firms that are registered with both agencies.
Section 407. Exemptions of venture capital fund advisers
The Committee believes that venture capital funds, a subset
of private investment funds specializing in long-term equity
investment in small or start-up businesses, do not present the
same risks as the large private funds whose advisers are
required to register with the SEC under this title. Their
activities are not interconnected with the global financial
system, and they generally rely on equity funding, so that
losses that may occur do not ripple throughout world markets
but are borne by fund investors alone. Terry McGuire, Chairman
of the National Venture Capital Association, wrote in
congressional testimony that ``venture capital did not
contribute to the implosion that occurred in the financial
system in the last year, nor does it pose a future systemic
risk to our world financial markets or retail investors.''\148\
Section 407 directs the SEC to define ``venture capital fund''
and provides that no investment adviser shall become subject to
registration requirements for providing investment advice to a
venture capital fund.
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\148\Capital Markets Regulatory Reform: Strengthening Investor
Protection, Enhancing Oversight of Private Pools of Capital, and
Creating a National Insurance Office: Testimony before the U.S. House
Committee on Financial Services, 111th Congress, 1st session, p.15
(2009) (Testimony of Mr. Terry McGuire).
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Section 408. Exemption of and record keeping by private equity fund
advisers
The Committee believes that private equity funds
characterized by long-term equity investments in operating
businesses do not present the same risks as the large private
funds whose advisers are required to register with the SEC
under this title. Private equity investments are characterized
by long-term commitments of equity capital--investors generally
do not have redemption rights that could force the funds into
disorderly liquidations of their positions. Private equity
funds use limited or no leverage at the fund level, which means
that their activities do not pose risks to the wider markets
through credit or counterparty relationships. Accordingly,
Section 408 directs the SEC to define ``private equity fund''
and provides an exemption from registration for advisers to
private equity funds.
Informed observers believe that in some cases the line
between hedge funds and private equity may not be clear, and
that the activities of the two types of funds may overlap. We
expect the SEC to define the term ``private equity fund'' in a
way to exclude firms that call themselves ``private equity''
but engage in activities that either raise significant
potential systemic risk concerns or are more characteristic of
traditional hedge funds. The section requires advisers to
private equity funds to maintain such records, and provide to
the SEC such annual or other reports, as the SEC determines
necessary and appropriate in the public interest and for the
protection of investors.
Section 409. Family offices
Family offices provide investment advice in the course of
managing the investments and financial affairs of one or more
generations of a single family. Since the enactment of the
Investment Advisers Act of 1940, the SEC has issued orders to
family offices declaring that those family offices are not
investment advisers within the intent of the Act (and thus not
subject to the registration and other requirements of the Act).
The Committee believes that family offices are not investment
advisers intended to be subject to registration under the
Advisers Act. The Advisers Act is not designed to regulate the
interactions of family members, and registration would
unnecessarily intrude on the privacy of the family involved.
Accordingly, Section 409 directs the SEC to define ``family
office'' and excludes family offices from the definition of
investment adviser Section 202(a)(11) of the Advisers Act.
Section 409 directs the SEC to adopt rules of general
applicability defining ``family offices'' for purposes of the
exemption. The rules shall provide for an exemption that is
consistent with the SEC's previous exemptive policy and that
takes into account the range of organizational and employment
structures employed by family offices. The Committee recognizes
that many family offices have become professional in nature and
may have officers, directors, and employees who are not family
members, and who may be employed by the family office itself or
by an affiliated entity. Such persons (and other persons who
may provide services to the family office) may co-invest with
family members, enabling them to share in the profits of
investments they oversee, and better aligning the interests of
such persons with those of the family members served by the
family office. The Committee expects that such arrangements
would not automatically exclude a family office from the
definition.
Section 410. State and federal responsibilities; asset threshold for
federal registration of investment advisers
Section 410 increases the asset threshold above which
investment advisers must register with the SEC from $25,000,000
to $100,000,000. States will have responsibility for regulating
advisers with less than $100,000,000 in assets under
management. The Committee expects that the SEC, by
concentrating its examination and enforcement resources on the
largest investment advisers, will improve its record in
uncovering major cases of investment fraud, and that the States
will provide more effective surveillance of smaller funds. In a
letter to Chairman Dodd and Ranking Member Shelby, the North
American Securities Administrators Association stated that
``State securities regulators are ready to accept the increased
responsibility for the oversight of investment advisers with up
to $100 million in assets under management. The state system of
investment adviser regulation has worked well with the $25
million threshold since it was mandated in 1996 and states have
developed an effective regulatory structure and enhanced
technology to oversee investment advisers. . . . An increase in
the threshold would allow the SEC to focus on larger investment
advisers while the smaller advisers would continue to be
subject to strong state regulation and oversight.''\149\
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\149\North American Securities Administrators Association, letter
to Chairman Dodd and Ranking Member Shelby, November 17, 2009.
---------------------------------------------------------------------------
In a letter to Senate Banking Committee staff in October
2009, Professor Mercer Bullard stated, ``I support the $100
million threshold. This merely restores the distribution of
advisers between the SEC and states that existed at the time
they were split by [the National Securities Markets Improvement
Act].''
Section 411. Custody of client assets
Section 411 requires registered investment advisers to
comply with SEC rules for the safeguarding of client assets and
to use independent public accountants to verify assets. The SEC
has recently adopted new rules imposing heightened standards
for custody of client assets. Mr. James Chanos, Chairman of the
Coalition of Private Investment Companies, wrote in testimony
for the Committee that ``Any new private fund legislation
should include provisions to reduce the risks of Ponzi schemes
and theft by requiring money managers to keep client assets at
a qualified custodian, and by requiring investment funds to be
audited by independent public accounting firms that are
overseen by the PCAOB.''\150\
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\150\Regulating Hedge Funds and Other Private Investment Pools:
Testimony before the Subcommittee on Securities, Insurance, and
Investment of the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p. 18 (2009) (Testimony of Mr.
James Chanos).
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Professor John Coffee wrote in testimony for the Senate
Banking Committee that ``the custodian requirement largely
removes the ability of an investment adviser to pay the
proceeds invested by new investors to old investors. The
custodian will take the instructions to buy or sell securities,
but not to remit the proceeds of sales to the adviser or to
others (except in return for share redemptions by investors).
At a stroke, this requirement eliminates the ability of the
manager to recycle' funds from new to old investors.''\151\ SEC
Inspector General H. David Kotz also supports this
provision.\152\
---------------------------------------------------------------------------
\151\Madoff Investment Securities Fraud: Regulatory and Oversight
Concerns and the Need for Reform: Testimony before the U.S. Senate
Committee on Banking, Housing, and Urban Affairs, 111th Congress, 1st
session, pp. 8,10 (2009) (Testimony of Professor John Coffee).
\152\SEC Inspector General H. David Kotz, letter to Senator Dodd,
October 29, 2009.
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Section 412. Adjusting the accredited investor standard for inflation
Accredited investor status, defined in SEC regulations
under the Securities Act of 1933, is required to invest in
hedge funds and other private securities offerings. Accredited
investors are presumed to be sophisticated, and not in need of
the investor protections afforded by the registration and
disclosure requirements that apply to public offerings. For
individuals, the accredited investor thresholds are dollar
amounts for annual income ($200,000 or $300,000 for an
individual and spouse) and net worth ($1 million, which may
include the value of a person's primary residence). These
amounts have not been adjusted since 1982; some observers
believe that because of inflation and real estate price
appreciation many individuals who now meet the accredited
investor standard may lack the degree of financial expertise
that was implied by the thresholds when they were established
nearly three decades ago. The North American Securities
Administrators Association wrote in a 2007 comment letter to
the SEC that ``NASAA has long advocated for adjusting the
definition of accredited investor' in light of inflation and
has expressed concern at the length of time the thresholds
contained in the definition have not been adjusted . . .
[I]nflation has seriously eroded the efficacy of the existing
thresholds in the definition of accredited investor' since
their adoption in 1982. NASAA further supports an inflation
adjustment every five years.''\153\
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\153\North American Securities Administrators Association, comment
letter in response to SEC proposed rule Revisions of Limited Offering
Exemptions in Regulation D, Release No. 33 8828; IC-27922; File No. S7-
18-07, October 26, 2007.
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Section 412 requires the SEC to increase the dollar
thresholds for accredited investor status, to take into account
price inflation since the current figures were established. The
Section also directs the SEC to adjust those figures at least
every five years to reflect the percentage increase in the cost
of living. This provision is intended to increase investor
protection by limiting participation in private securities
offerings to investors who are capable of evaluating the risks
of such offerings.
Section 413. GAO study and report on accredited investors
Section 413 directs the GAO to submit a report on the
appropriate criteria for accredited investor status and
eligibility to invest in private funds. The goal of the
exemptions for accredited investors is to identify a category
of investors who have sufficient knowledge and expertise to
fend for themselves in making investment decisions. Currently,
this category is identified by salary or wealth. However, we
recognize that these are imperfect standards. For example, a
person's wealth may include a valuable primary residence but
little liquid cash, or a wealthy person may be a widow or
widower with a large inheritance, but little investment
expertise. Accordingly, we ask the GAO to determine whether
other measures would be more appropriate.
Section 414. GAO study on self-regulatory organization for private
funds
Section 414 directs the GAO to study the feasibility of
creating a self-regulatory organization to oversee private
funds--which can include hedge funds, private equity funds, and
venture capital funds.
Section 415. Commission study and report on short selling
Section 415 directs the Office of Risk, Strategy, and
Financial Innovation of the SEC to conduct a study on the
current state of short selling, the impact of recent SEC rules,
the recent incidence of failures to deliver, the practice of
delivering shares sold short on the fourth day following the
trade, and consideration of real time reporting of short
positions.
Section 416. Transition period
Section 416 provides that the title becomes effective one
year after the date of enactment of this Act, but advisers to
private funds may voluntarily register with the SEC during that
1-year period.
Title V--Insurance
Subtitle A--Office of National Insurance
Section 501. Short title
Section 502. Establishment of Office of National Insurance
This section establishes the Office of National Insurance
(``Office'') within the Department of the Treasury. The Office,
to be headed by a career Senior Executive Service Director
appointed by the Secretary of the Treasury (``Secretary''),
will have the authority to: (1) monitor all aspects of the
insurance industry; (2) recommend to the Financial Stability
Oversight Council (``Council'') that the Council designate an
insurer, including its affiliates, as an entity subject to
regulation by the Board of Governors as a nonbank financial
company as defined in Title I of the Restoring American
Financial Stability Act; (3) assist the Secretary in
administering the Terrorism Risk Insurance Program; (4)
coordinate Federal efforts and establish Federal policy on
prudential aspects of international insurance matters; (5)
determine whether State insurance measures are preempted by
International Insurance Agreements on Prudential Measures; and
(6) consult with the States regarding insurance matters of
national importance and prudential insurance matters of
international importance. The authority of the Office extends
to all lines of insurance except health insurance and crop
insurance.
In carrying out its functions, the Office may collect data
and information on the insurance industry and insurers, as well
as issue reports. It may require an insurer or an affiliate to
submit data or information reasonably required to carry out
functions of the Office, although the Office may establish an
exception to data submission requirements for insurers meeting
a minimum size threshold. Before collecting any data or
information directly from an insurer, the Office must first
coordinate with each relevant State insurance regulator (or
other relevant Federal or State regulatory agency, in the case
of an affiliate) to determine whether the information is
available from such State insurance regulator or other
regulatory agency. The Office will have power to require by
subpoena that an insurer produce the data or information
requested, but only upon a written finding by the Director that
the data or information is required to carry out its functions
and that it has coordinated with relevant regulator or agency
as required. The subpoena authority is intended to be an option
of last resort that would very rarely be used, since it is
expected that the relevant regulator or agency and the insurers
would cooperate with reasonable requests for data or
information by the Office. Any non-publicly available data and
information submitted to the Office will be subject to
confidentiality provisions: privileges are not waived; any
requirements regarding privacy or confidentiality will continue
to apply; and information contained in examination reports will
be considered subject to the applicable exemption under the
Freedom of Information Act for this type of information.
The Director will determine whether a State insurance
measure is preempted because it: (a) results in less favorable
treatment of a non-United States insurer domiciled in a foreign
jurisdiction that is subject to an International Insurance
Agreement on Prudential Measures than a United States insurer
domiciled, licensed, or otherwise admitted in that State and
(b) is inconsistent with an International Insurance Agreement
on Prudential Measures. However, the savings clause provides
that nothing in this section preempts any State insurance
measure that governs any insurer's rates, premiums,
underwriting or sales practices, State coverage requirements
for insurance, application of State antitrust laws to the
business of insurance, or any State insurance measure governing
the capital or solvency of an insurer (except to the extent
such measure results in less favorable treatment of a non-
United States insurer than a United States insurer). The
savings clause is intended to shield these important State
consumer protection measures from preemption.
An ``International Insurance Agreement on Prudential
Measures'' is defined as a written bilateral or multilateral
agreement entered into between the United States and a foreign
government, authority, or regulatory entity regarding
prudential measures applicable to the business of insurance or
reinsurance. Before making a determination of inconsistency,
the Director will notify and consult with the appropriate
State, publish a notice in the Federal Register, and give
interested parties the opportunity to submit comments. Upon
making the determination, the Director will notify the
appropriate State and Congress, and establish a reasonable
period of time before the preemption will become effective. At
the conclusion of that period, if the basis for the
determination still exists, the Director will publish a notice
in the Federal Register that the preemption has become
effective and notify the appropriate State.
The Director will consult with State insurance regulators,
to the extent the Director determines appropriate, in carrying
out the functions of the Office. The Director may also consult
on insurance matters with Indian Tribes (as defined in Section
4(e) of the Indian Self-Determination and Education Assistance
Act, as amended (25 U.S.C. 450b(e))) regarding insurance
entities wholly owned by Indian Tribes. Nothing in this section
will be construed to give the Office or the Treasury Department
general supervisory or regulatory authority over the business
of insurance.
The Director must submit a report to the President and to
Congress by September 30th of each year on the insurance
industry and any actions taken by the Office regarding
preemption of inconsistent State insurance measures.
The Director must also conduct a study and submit a report
to Congress within 18 months of the enactment of this section
on how to modernize and improve the system of insurance
regulation in the United States. The study and report must be
guided by the following six considerations: (1) systemic risk
regulation with respect to insurance; (2) capital standards and
the relationship between capital allocation and liabilities;
(3) consumer protection for insurance products and practices;
(4) degree of national uniformity of state insurance
regulation; (5) regulation of insurance companies and
affiliates on a consolidated basis; and (6) international
coordination of insurance regulation. The study and report must
also examine additional factors as set forth in this section.
This section also authorizes the Secretary of the Treasury
to negotiate and enter into International Insurance Agreements
on Prudential Measures on behalf of the United States. However,
nothing in this section will be construed to affect the
development and coordination of the United States international
trade policy or the administration of the United States trade
agreements program. The Secretary will consult with the United
States Trade Representative on the negotiation of International
Insurance Agreements on Prudential Measures, including prior to
initiating and concluding any such agreements.
Subtitle B--State-Based Insurance Reform
Section 511. Short title
This subtitle may be cited as the ``Nonadmitted and
Reinsurance Reform Act of 2009''.
Section 512. Effective date
Part I--Nonadmitted Insurance
Sec. 521. Reporting, payment, and allocation of premium taxes
Gives the home State of the insured (policyholder) sole
regulatory authority over the collection and allocation of
premium tax obligations related to nonadmitted insurance (also
known as surplus lines insurance). States are authorized to
enter into a compact or other agreement to establish uniform
allocation and remittance procedures. Insured's home State may
require surplus lines brokers and insureds to file tax
allocation reports detailing portion of premiums attributable
to properties, risks, or exposures located in each state.
Sec. 522. Regulation of nonadmitted insurance by insured's home state
Unless otherwise provided, insured's home State has sole
regulatory authority over nonadmitted insurance, including
broker licensing.
Sec. 523. Participation in national producer database
State may not collect fees relating to licensing of
nonadmitted brokers unless the State participates in the
national insurance producer database of the National
Association of Insurance Commissioners (NAIC) within 2 years of
enactment of this subtitle.
Sec. 524. Uniform standards for surplus lines eligibility
Streamlines eligibility requirements for nonadmitted
insurance providers with the eligibility requirements set forth
in the NAIC's Nonadmitted Insurance Model Act.
Sec. 525. Streamlined application for commercial purchasers
Allows exempt commercial purchasers, as defined in section
527, easier access to the non-admitted marketplace by waiving
certain requirements.
Sec. 526. GAO study of nonadmitted insurance market
The Comptroller General shall conduct a study of the
nonadmitted insurance market to determine the effect of the
enactment of this part on the size and market share of the
nonadmitted market. The Comptroller General shall consult with
the NAIC and produce this report within 30 months after the
effective date.
Sec. 527. Definitions
Among others, defines Exempt Commercial Purchasers and
details the qualifications necessary to qualify as such for the
purposes of section 525.
Part II--Reinsurance
Sec. 531. Regulation of credit for reinsurance and reinsurance
agreements
Prohibits non-domiciliary States from denying credit for
reinsurance if the State of domicile of a ceding insurer is an
NAIC-accredited State or has solvency requirements
substantially similar to those required for NAIC accreditation.
Prohibits non-domiciliary States from restricting or
eliminating the rights of reinsurers to resolve disputes
pursuant to contractual arbitration clauses, prohibits non-
domiciliary States from ignoring or eliminating contractual
agreements on choice of law determinations, and prohibits non-
domiciliary States from enforcing reinsurance contracts on
terms different from those set forth in the reinsurance
contract.
Sec. 532. Solvency regulation
State of domicile of the reinsurer is solely responsible
for regulating the financial solvency of the reinsurer. Non-
domiciliary States may not require reinsurer to provide any
additional financial information other than the information
required by State of domicile. Non-domiciliary States are
required to be provided with copies of the financial
information that is required to be filed with the State of
domicile.
Sec. 533. Definitions
Among others, defines a reinsurer and clarifies how an
insurer could be determined as a reinsurer under the laws of
the state of domicile.
Part III--Rule of Construction
Sec. 541. Rule of construction
Clarifies that this subtitle will not modify, impair, or
supersede the application of antitrust laws, confirms that any
potential conflict between this subtitle and the antitrust laws
will be resolved in favor of the operation of the antitrust
laws.
Sec. 542. Severability
States that if any section, subsection, or application of
this subtitle is held to be unconstitutional, the remainder of
the subtitle shall not be affected.
Title VI--Bank and Savings Association Holding Company and Depository
Institution Regulatory Improvements Act of 2009
Section 601. Short title
The short title of this section is the ``Bank and Savings
Association Holding Company and Depository Institution
Regulatory Improvements Act of 2010.''
Section 602. Definitions
This section defines the term ``commercial firm'' as any
entity that derives not less than 15 percent of the
consolidated annual gross revenues of the entity, including all
affiliates of the entity, from engaging in activities that are
not financial in nature or incidental to activities that are
financial in nature, as provided in section 4(k) of the Bank
Holding Company Act of 1956 (12 U.S.C. 1843(k)).
Section 603. Moratorium and study on treatment of credit card banks,
industrial loan companies, trust banks and certain other
companies as bank holding companies under the Bank Holding
Company Act
This section imposes a three-year moratorium on the ability
of the Federal Deposit Insurance Corporation to approve a new
application for deposit insurance for an industrial loan
company, credit card bank, or trust bank that is owned or
controlled by a commercial firm. During this period, the
appropriate Federal banking agency may not approve a change in
control of an industrial bank, a credit card bank, or a trust
bank if the change in control would result in direct or
indirect control of the industrial bank, credit card bank, or
trust bank by a commercial firm, unless the bank is in danger
of default, or unless the change in control results from the
merger or whole acquisition of a commercial firm that directly
or indirectly controls the industrial bank, credit card bank,
or trust bank in a bona fide merger with or acquisition by
another commercial firm.
In addition, this section provides that within 18 months of
enactment of this Act, the Comptroller General must submit a
report to Congress analyzing whether it is necessary to
eliminate the exceptions in the Bank Holding Company Act of
1956 (BHCA) for credit card banks, industrial loan companies,
trust banks, thrifts, and certain other companies, in order to
strengthen the safety and soundness of these institutions or
the stability of the financial system.
The Treasury Department's legislative proposal for
financial reform includes a provision that would have
eliminated the exceptions in the BHCA for credit card banks,
industrial loan companies, trust banks and certain other
limited purpose banks.\154\ Under this proposal, firms owning
such companies, including commercial firms, would have been
subject to regulation as bank holding companies. As a
consequence, these firms would have been required to divest of
certain financial businesses in accordance with BHCA activity
limitations, and would have been subject to new capital
requirements. The Committee is seeking additional information
through the GAO to determine whether this new supervisory
regime should be applied to firms that own credit card banks,
industrial loan companies, trust banks, or other limited
purpose banks.
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\154\FACT SHEET: ADMINISTRATION'S REGULATORY REFORM AGENDA MOVES
FORWARD; Legislation for Strengthening Investor Protection Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 10,
2009, www.financialstability.gov.
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Section 604. Reports and examinations of bank holding companies;
regulation of functionally regulated subsidiaries
This section removes limitations on the ability of the
appropriate Federal banking agency (AFBA) for a bank or savings
and loan holding company to obtain reports from, examine, and
regulate all subsidiaries of the holding company. The Committee
agrees with testimony provided by Governor Daniel K. Tarullo,
on behalf of the Board of Governors of the Federal Reserve
System (Federal Reserve) ``that to be fully effective,
consolidated supervisors need the information and ability to
identify and address risk throughout an organization.''\155\
For this reason, this section removes the so-called Fed-lite
provisions of the Gramm-Leach-Bliley Act that placed
limitations on the ability of the Federal Reserve to examine,
obtain reports from, or take actions to identify or address
risks with respect to subsidiaries of a bank holding company
that are supervised by other agencies. However, this section
also requires the AFBA for the holding company to coordinate
with other Federal and state regulators of subsidiaries of the
holding company, to the fullest extent possible, to avoid
duplication of examination activities, reporting requirements,
and requests for information.
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\155\Strengthening and Streamlining Prudential Bank Supervision--
Part I: Testimony of Daniel K. Tarullo, Member Board of Governors of
the Federal Reserve System, before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 2nd session, p.13
(August 4, 2009).
---------------------------------------------------------------------------
While the Committee supports consolidated regulation, it
also supports coordinated regulation. Accordingly, section
604(b) requires the AFBA for a bank holding company to give
prior notice to, and to consult with, the primary regulator of
a subsidiary before commencing an examination of that
subsidiary. The section contains an identical requirement with
respect to the examination by the AFBA for a savings and loan
holding company of a subsidiary of a savings and loan holding
company. Other provisions in section 604 specifically require
the holding company regulator to rely ``to the fullest extent
possible'' on reports and supervisory information that are
available from sources other than the subsidiary itself,
including information that is ``otherwise available'' from
other Federal or State regulators of the subsidiary. These
provisions effectively require that the holding company
regulator provide notice to and consult with the primary
regulator, e.g., the appropriate Federal banking agency for a
depository institution, to identify the information it wants
and ascertain whether that information already is available
from the primary regulator. In addition, section 604
specifically requires the AFBA for the holding company to
coordinate with other Federal and state regulators of
subsidiaries of the holding company, ``to the fullest extent
possible, to avoid duplication of examination activities,
reporting requirements, and requests for information.''
This section also requires the AFBA for the holding company
to consider risks to the stability of the United States banking
or financial system when reviewing bank holding company
proposals to engage in mergers, acquisitions, or nonbank
activities or financial holding company proposals to engage in
activities that are financial in nature. A financial holding
company also may not engage in certain activities that are
financial in nature without the approval of the AFBA for the
holding company if they involve the acquisition of assets that
exceed $25 billion.
In addition, the section amends the Home Owners' Loan Act
to clarify the authority of the AFBA of a savings and loan
holding company to examine and require reports from the savings
and loan holding company and all of its subsidiaries. It also
directs the AFBA to coordinate its supervisory activities with
other Federal and state regulators of the holding company
subsidiaries.
Section 605. Assuring consistent oversight of permissible activities of
depository institution subsidiaries of holding companies
This section requires the ``lead Federal banking agency''
for each depository institution holding company to examine the
bank permissible activities of each non-depository institution
subsidiary (other than a functionally regulated subsidiary) of
the depository institution holding company to determine whether
the activities present safety and soundness risks to any
depository institution subsidiary of the holding company. For
purposes of this section, ``lead Federal banking agency'' is
defined as (1) the Office of the Comptroller of the Currency
for holding companies with Federally-chartered depository
institution subsidiaries, or where total consolidated assets in
its Federally-chartered depository institution subsidiaries
exceed those in its State-chartered depository institution
subsidiaries or (2) the Federal Deposit Insurance Corporation
for holding companies with state-chartered depository
institution subsidiaries, or where total consolidated assets in
its state-chartered depository institution subsidiaries exceed
those in its Federally-chartered depository institution
subsidiaries. The ``lead Federal banking agency'' can recommend
that the Federal Reserve take enforcement action against a non-
depository subsidiary where the Board is the holding company
regulator. If the Federal Reserve does not take enforcement
action within 60-days of receiving the recommendation, the
``lead Federal banking agency'' may take enforcement action
against the non-depository institution.
This provision addresses the problem of the uneven
supervisory standards under today's regulatory regime,
applicable to depository and non-depository subsidiaries
holding companies, highlighted by John C. Dugan, Comptroller of
the Currency, in his testimony before the Committee. Changes
made by this section are consistent with the recommendation of
Comptroller Dugan that where subsidiaries are engaged in the
same business as is conducted, or could be conducted, by an
affiliated bank mortgage or other consumer lending, for example
the prudential supervisor already has the resources and
expertise needed to examine the activity. Affiliated companies
would then be made subject to the same standards and examined
with the same frequency as the affiliated bank. This approach
also would ensure that the placement of an activity in a
holding company structure could not be used to arbitrage
between different supervisory regimes or approaches.\156\
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\156\Strengthening and Streamlining Prudential Bank Supervision--
Part I: Testimony of John C. Dugan, Comptroller of the Currency, before
the U.S. Senate Committee on Banking, Housing, and Urban Affairs, 111th
Congress, 2nd session, p.17 (August 4, 2009).
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Section 606. Requirements for financial holding companies to remain
well capitalized and well managed
This section amends the BHCA to require all financial
holding companies engaging in expanded financial activities to
remain well capitalized and well managed.
Section 607. Standards for interstate acquisitions and mergers
This section raises the capital and management standards
for bank holding companies engaging in interstate bank
acquisitions by requiring them to be well capitalized and well
managed. In addition, interstate mergers of banks will only be
permitted if the resulting bank is well capitalized and well
managed.
Section 608. Enhancing existing restrictions on bank transactions with
affiliates
This section amends section 23A of the Federal Reserve Act
by, among other things, defining an investment fund, for which
a member bank is an investment adviser, as an affiliate of the
member bank.
It also adds credit exposure from a securities borrowing or
lending transaction or derivative transaction to the list of
inter-affiliate ``covered transactions'' in section 23A. The
Federal Reserve is provided the discretion to define ``credit
exposure.'' In addition, the Federal Reserve may issue
regulations or interpretations with respect to the manner in
which a netting agreement may be taken into account in
determining the amount of a covered transaction between a
member bank or a subsidiary and an affiliate, including the
extent to which netting agreements between a member bank or a
subsidiary and an affiliate may be taken into account in
determining whether a covered transaction is fully secured for
purposes of subsection (d)(4) of section 23A.
This provision represents a second attempt by Congress to
address the credit exposure to banks from affiliate derivative
transactions. Section 121 of the Gramm-Leach-Bliley Act
provided that ``not later than 18 months after November 12,
1999, the Federal Reserve shall adopt final rules under this
section [23A of the Federal Reserve Act] to address as covered
transactions credit exposure arising out of derivative
transactions between member banks and their affiliates.''\157\
In 2002, the Federal Reserve announced that it ``expects to
issue, in the near future, a proposed rule that would invite
public comment on how to treat as covered transactions under
section 23A certain derivative transactions that are the
functional equivalent of a loan by a member bank to an
affiliate or the functional equivalent of an asset purchase by
a member bank from an affiliate.''\158\ However, the proposed
rule was not issued.
---------------------------------------------------------------------------
\157\Pub. L. 106-102, Title I, section 121(b), 113 Stat. 1378
(November 12, 1999).
\158\69 Fed Reg. 239 (December 12, 2002).
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The bank regulatory framework must address bank credit
exposure to affiliates from derivative transactions to limit a
bank's exposure to loss in the event of the failure of an
affiliate. Over the last two years, the Committee has heard
testimony regarding the damage to the U.S. economy caused by
derivatives. Inter-affiliate derivative transactions are a
major source of intra-firm complexity among the largest
depository institutions. Moreover, tight limits on traditional
credit exposures of banks to affiliates, such as loans, and no
limits on nontraditional credit exposures of banks to
affiliates, such as derivatives, have created a perverse
incentive for banks to engage with their affiliates in these
more complex, volatile and opaque transaction forms.
Placing limits on derivative transactions will result in
greater transparency and disclosure of derivative transactions
between banks and their affiliates, a reduction in the volume
of internal risk-shifting transactions, and in the
simplification of the internal structures of our major
financial firms.
Section 609. Eliminating exceptions for transactions with financial
subsidiaries
This section amends section 23A of the Federal Reserve Act
by eliminating the special treatment for transactions with
financial subsidiaries.
Section 610. Lending limits applicable to credit exposure on derivative
transactions, repurchase agreements, reverse repurchase
agreements, and securities lending and borrowing transactions
This section tightens national bank lending limits by
treating credit exposures on derivatives, repurchase
agreements, and reverse repurchase agreements as extensions of
credit for the purposes of national bank lending limits.
Accordingly, banks must take into account these exposures for
purposes of the affiliate transaction limitations described in
section 608, the insider transaction limits described in
section 614, but also for purposes of lending limits that apply
to non-affiliated third parties.
Section 611. Application of national bank lending limits to insured
state banks
This section requires all insured depository institutions
to comply with national bank lending limits. This legislation
applies national bank lending limits to insured state banks for
several reasons. First, lending limits restrict the percentage
of a bank's capital that can be loaned to a single borrower and
are one of the core safety and soundness laws applicable to
bank operations. In almost all similar areas involving safety
and soundness (capital adequacy, affiliate transaction limits,
limits on loans to executive officers, and limits on loans to
insiders) there is a uniform Federal standard that applies to
all insured depository institutions. It is the view of the
Committee that, as a matter of good public policy, banks should
be subject to a uniform Federal standard with respect to
lending limits, and should not compete on the basis of
differences in safety and soundness regulation. A second reason
relates to section 610 of the legislation that requires
exposure from derivatives transactions to be included in
Federal lending limits. State bank lending limits typically do
not address derivatives. This section addresses the Committee's
concern that if uniform restrictions in this area do not apply
across the banking sector, risky derivative activities could
migrate to state banks, or national banks may seek state
charters to escape from regulation in this area. This section
includes a 2-year transition period to ensure that state banks
have adequate time to implement these new limits.
Section 612. Restriction on conversions of troubled banks and savings
associations
This section prohibits conversions from a national bank
charter to a state bank or savings association charter or vice
versa during any time in which a bank or savings association is
subject to a cease and desist order, other formal enforcement
action, or memorandum of understanding. It also prohibits the
conversion of a federal savings association to a national or
state bank or state savings association under these
circumstances.
As Governor Daniel K. Tarullo noted in his testimony to the
Committee, on behalf of the Federal Reserve, ``while
institutions may engage in charter conversions for a variety of
sound business reasons, conversions that are motivated by a
hope of escaping current or prospective supervisory actions by
the institution's existing supervisor undermine the efficacy of
the prudential supervisory framework.''\159\ The Federal
Financial Institutions Examination Council (FFIEC) recently
issued a Statement on Regulatory Conversions declaring that
supervisors will only consider applications undertaken for
legitimate reasons and will not entertain regulatory conversion
applications that undermine the supervisory process.\160\ This
section codifies this important principle.
---------------------------------------------------------------------------
\159\Strengthening and Streamlining Prudential Bank Supervision--
Part I: Testimony of Daniel K. Tarullo, Member Board of Governors of
the Federal Reserve System, before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 2nd session, p. 13
(August 4, 2009).
\160\Federal Financial Institutions Examination Council (2009),
``FFIEC Issues Statement on Regulatory Conversions, press release, July
1, www.ffiec.gov/press/pr070109.htm.
---------------------------------------------------------------------------
Section 613. De novo branching into states
This section expands the ability of a national bank or
state bank to establish a de novo branch in another state. In
the age of Internet transactions, such branching restrictions
are anachronistic and ineffectual.
Section 614. Lending limits to insiders
This section expands the type of transactions subject to
insider lending limits to include derivatives transactions,
repurchase agreements, reverse repurchase agreements, and
securities lending or borrowing transactions. This section is
consistent with this legislation's expansion of affiliate
transaction limits in section 608, and lending limits
applicable to non-affiliated third parties in section 610, and
to include such exposures.
Section 615. Limitations on purchases of assets from insiders
This section prohibits insured depository institutions from
entering into asset purchase or sales transactions with its
executive officers, directors, or principal shareholders or a
related interest unless the transaction is on market terms and,
if the transaction represents more than ten percent of the
capital and surplus of the institution, has been approved in
advance by a majority of the disinterested members of the
board.
This section replaces and expands a similar provision in
section 22(d) of the Federal Reserve Act (12 U.S.C. 375) that
simply restricts purchases and sales transactions between a
member bank and its directors.
Section 616. Rules regarding capital levels of holding companies
This section clarifies that the Federal Reserve may adopt
rules governing the capital levels of bank and savings and loan
holding companies. According to testimony provided to the
Committee by John C. Dugan, Comptroller of the Currency, under
the current regulatory system, ``thrift holding companies,
unlike bank holding companies, are not subject to consolidated
regulation for example, no consolidated capital requirements
apply at the holding company level. This difference between
bank and thrift holding company regulation created arbitrage
opportunities for companies that were able to take on greater
risk under a less rigorous regulatory regime.''\161\ This
section provides the Federal Reserve with the same authority to
prescribe capital standards for savings and loan holding
companies that it currently has for bank holding companies. It
is the intent of the Committee that in issuing regulations
relating to capital requirements of bank holding companies and
savings and loan holding companies under this section, the
Federal Reserve should take into account the regulatory
accounting practices and procedures applicable to, and capital
structure of, holding companies that are insurance companies
(including mutuals and fraternals), or have subsidiaries that
are insurance companies.
---------------------------------------------------------------------------
\161\Strengthening and Streamlining Prudential Bank Supervision--
Part I: Testimony of John C. Dugan, Comptroller of the Currency, before
the U.S. Senate Committee on Banking, Housing, and Urban Affairs, 111th
Congress, 2nd session, p.7 (August 4, 2009).
---------------------------------------------------------------------------
This section also directs the AFBA for a bank or savings
and loan holding company to require the company to serve as a
source of financial strength for any insured depository
institution that the company owns or controls. If an insured
depository institution is not the subsidiary of a bank or
savings and loan holding company, the AFBA for the insured
depository institution must require any company that owns or
controls the insured depository institution to serve as a
source of financial strength for the institution. The AFBA for
such an insured depository institution may, from time to time,
require the company, or a company that directly or indirectly
controls the depository to submit a report, under oath, for the
purposes of assessing the ability of the company to comply with
the source of strength requirement, and for purposes of
enforcing the company's compliance with the source of strength
requirement. It is the intent of the Committee that such
companies will be permitted to provide financial reporting to
the AFBA utilizing the accounting method they currently employ
in reporting their financial information. More specifically,
nothing in this provision is intended to mandate that insurance
companies otherwise subject to alternative regulatory
accounting practices and procedures use GAAP reporting.
Section 617. Elimination of elective investment bank holding company
framework
This section eliminates the elective Investment Bank
Holding Company Framework in the Securities Exchange Act of
1934. This repeals the current supervised investment bank
holding company program under which the Securities and Exchange
Commission may supervise a non-bank securities firm that is
required by a foreign regulator to be subject to consolidated
supervision by a U.S. regulator and replaces this program with
the supervisory regime described in section 618.
Section 618. Securities holding companies
This section permits a securities holding company, not
otherwise regulated by an AFBA, that is required by a foreign
regulator to be subject to comprehensive consolidated
supervision to register with the Federal Reserve to become a
``supervised securities holding company.'' To qualify, a
securities holding company must own or control one or more
brokers or dealers registered with the Securities and Exchange
Commission, and cannot be a nonbank financial company
supervised by the Board, an affiliate of an insured bank or
savings association, a foreign bank, or subject to
comprehensive consolidated supervision by a foreign regulator.
This section describes the manner in which the Board must
supervise and regulate ``supervised securities holding
companies,'' including through issuance of regulations that
prescribe capital adequacy and other risk management standards
to protect the safety and soundness of the company and to
address risks posed to financial stability by such companies.
Section 619. Restrictions on capital market activity by banks and bank
holding companies
The intent of this section is to prohibit or restrict
certain types of financial activity--in banks, bank holding
companies, other companies that control an insured depository
institution, their subsidiaries, or nonbank financial companies
supervised by the Board of Governors--that are high-risk or
which create significant conflicts of interest between these
institutions and their customers. The prohibitions and
restrictions are intended to limit threats to the safety and
soundness of the institutions, to limit threats to financial
stability, and eliminate any economic subsidy to high-risk
activities that is provided by access to lower-cost capital
because of participation in the regulatory safety net.
Subject to recommendations and modifications by the
Financial Stability Oversight Council, an insured depository
institution, a company that controls an insured depository
institution or is treated as a bank holding company for
purposes of the Bank Holding Company Act, and any subsidiary of
such institution or company, will be prohibited from
proprietary trading, sponsoring and investing in hedge funds
and private equity funds, and from having certain financial
relationships with those hedge funds or private equity funds
for which they serve as investment manager or investment
adviser. A nonbank financial institution supervised by the
Board of Governors that engages in proprietary trading, or
sponsoring or investing in hedge funds and private equity funds
will be subject to Board rules imposing capital requirements
relate to, or quantitative limits on, these activities. These
prohibitions and restrictions will be subject to certain
exemptions.
The Council recommendations and modifications will be
included in a study to assess the extent to which the
prohibitions, limitations and requirements of section 619 will
promote several goals, including: the safety and soundness of
depositories and their affiliates; protecting taxpayers from
loss; limiting the inappropriate transfer of economic subsidies
from institutions that benefit from deposit insurance and
liquidity facilities of the Federal government to unregulated
entities; reducing inappropriate conflicts of interest between
depositories and their affiliates, or financial companies
supervised by the Board of Governors, and their customers;
affecting the cost of credit or other financial services,
limiting undue risk or loss in financial institutions; and
appropriately accommodating the business of insurance within
insurance companies subject to State insurance company
investment laws.
The Council study is included to assure that the
prohibitions included in section 619 work effectively. It is
not the intent of the section to interfere inadvertently with
longstanding, traditional banking activities that do not
produce high levels of risk or significant conflicts of
interest. For that reason the Council is given some latitude to
make needed modifications to definitions and provisions in
order to prevent undesired outcomes. However, it is intended
that the Council will determine how to effectively implement
the prohibitions and restrictions of the section, and not to
weaken them.
The Council will have six months to write the study, and
the appropriate Federal bank agencies will have nine months in
which to issue regulations that reflect the recommendations of
the Council.
Paul Volcker, chairman of the President's Economic Recovery
Advisory Board and former chairman of Board of Governors of the
Federal Reserve, has strongly advocated that beneficiaries of
the federal financial safety net be prohibited from engaging in
high-risk activities. In the statement he submitted to the
Senate Committee on Banking, Housing and Urban Affairs on
February 2, Mr. Volcker argued that there is no public policy
rationale for subsidizing high risk activities:
The basic point is that there has been, and remains,
a strong public interest in providing a ``safety
net''--in particular, deposit insurance and the
provision of liquidity in emergencies--for commercial
banks carrying out essential services. There is not,
however, a similar rationale for public funds--taxpayer
funds--protecting and supporting essentially
proprietary and speculative activities. Hedge funds,
private equity funds, and trading activities unrelated
to customer needs and continuing banking relationships
should stand on their own, without the subsidies
implied by public support for depository institutions.
He also went on to note that these high-risk activities
produce unacceptable conflicts of interest in insured and
regulated institutions:
. . . I want to note the strong conflicts of interest
inherent in the participation of commercial banking
organizations in proprietary or private investment
activity. That is especially evident for banks
conducting substantial investment management
activities, in which they are acting explicitly or
implicitly in a fiduciary capacity. When the bank
itself is a ``customer'', i.e., it is trading for its
own account, it will almost inevitably find itself,
consciously or inadvertently, acting at cross purposes
to the interests of an unrelated commercial customer of
a bank. ``Inside'' hedge funds and equity funds with
outside partners may generate generous fees for the
bank without the test of market pricing, and those same
``inside'' funds may be favored over outside
competition in placing funds for clients. More
generally, proprietary trading activity should not be
able to profit from knowledge of customer trades.
At the same hearing Deputy Treasury Secretary Neal Wolin
emphasized the volatility and riskiness of the activities that
are prohibited under section 619. In his statement he noted
that:
Major firms saw their hedge funds and proprietary
trading operations suffer large losses in the financial
crisis. Some of these firms ``bailed out'' their
troubled hedge funds, depleting the firm's capital at
precisely the moment it was needed most. The complexity
of owning such entities has also made it more difficult
for the market, investors, and regulators to understand
risks in major financial firms, and for their managers
to mitigate such risks. Exposing the taxpayer to
potential risks from these activities is ill-advised.
Section 620. Concentration limits on large financial firms
Subject to recommendations from the Financial Stability
Oversight Council, a financial company may not merge or
consolidate with, acquire all or substantially all of the
assets of, or otherwise acquire control of, another company, if
the total consolidated liabilities of the acquiring financial
company upon consummation of the transaction would exceed 10
percent of the aggregate consolidated liabilities of all
financial companies at the end of the calendar year preceding
the transaction.
The Council recommendations will be included in a study of
the extent to which the concentration limit under section 620
would affect financial stability, moral hazard in the financial
system, the efficiency and competitiveness of United States
financial firms and financial markets, and the cost and
availability of credit and other financial services to
households and businesses in the United States. The intent is
to have the Council determine how to effectively implement the
concentration limit, and not whether to do so.
The Council will have six months to write the study, and
the Board of Governors of the Federal Reserve will have nine
months in which to issue regulations that reflect the
recommendations and modifications of the Council.
Title VII--Over-the-Counter Derivatives Markets Act of 2009
Section 701. Short title
Section 701. Findings and purposes
This section describes the findings and purposes of the
Over-the-Counter Derivatives Markets Act of 2009. In order to
mitigate costs and risks to taxpayers and the financial system,
this Act establishes regulations for the over-the-counter
derivatives market including requirements for clearing,
exchange trading, capital, margin, and reporting.
Subtitle A--Regulation of Swap Markets
Section 711. Definitions
This section adds new definitions to the Commodity Exchange
Act and directs the Commodity Futures Trading Commission
(``CFTC'') and Securities and Exchange Commission (``SEC'') to
jointly adopt uniform interpretations. The defined terms
include ``swap,'' ``swap dealer,'' ``swap repository,'' and
``major swap participant.''
This section also establishes guidelines for joint CFTC and
SEC rulemaking authority under this Act. This section requires
that rules and regulations prescribed jointly under this Act by
the CFTC and SEC shall be uniform and shall treat functionally
or economically equivalent products similarly. This section
authorizes the CFTC and SEC to prescribe rules defining
``swap'' and ``security-based swap'' to prevent evasions of
this Act. This section also requires the CFTC and SEC to
prescribe joint rules in a timely manner and authorizes the
Financial Stability Oversight Council to resolve disputes if
the CFTC and SEC fail to jointly prescribe rules.
Section 712. Jurisdiction
This section removes limitations on the CFTC's jurisdiction
with respect to certain derivatives transactions, including
swap transactions between ``eligible contract participants.''
Section 713. Clearing
Subsection (a). Clearing requirement
This subsection requires clearing of all swaps that are
accepted for clearing by a registered derivatives clearing
organization unless one of the parties to the swap qualifies
for an exemption. This subsection requires cleared swaps that
are accepted for trading to be executed on a designated
contract market or on a registered alternative swap execution
facility. The CFTC may exempt a party to a swap from the
clearing and exchange trading requirement if one of the
counterparties to the swap is not a swap dealer or major swap
participant and does not meet the eligibility requirements of
any derivatives clearing organization that clears the swap. The
CFTC must consult the Financial Stability Oversight Council
before issuing an exemption. Requires a party to a swap to
submit the swap for clearing if a counterparty requests that
such swap be cleared and the swap is accepted for clearing by a
registered derivatives clearing organization.
This subsection requires derivatives clearing organizations
to seek approval from the CFTC prior to clearing any group or
category of swaps and directs the CFTC and SEC to jointly adopt
rules to further identify any group or category of swaps
acceptable for clearing based on specified criteria; authorizes
the CFTC and SEC jointly to prescribe rules or issue
interpretations as necessary to prevent evasions of section
2(j) of the Commodity Exchange Act; and requires parties who
enter into non-cleared swaps to report such transactions to a
swap repository or the CFTC.
Subsection (b). Derivatives clearing organizations
This subsection requires derivatives clearing organizations
that clear swaps to register with the CFTC, and directs the
CFTC and SEC (in consultation with the appropriate federal
banking agencies) to jointly adopt uniform rules governing
entities registered as derivatives clearing organizations for
swaps under this subsection and entities registered as clearing
agencies for security-based swaps under the Securities Exchange
Act of 1934 (``Exchange Act''). This subsection also permits
dual registration of a derivatives clearing organization with
the CFTC and SEC or appropriate banking agency, authorizes the
CFTC to exempt from registration under this subsection a
derivatives clearing organization that is subject to
comparable, comprehensive supervision and regulation on a
consolidated basis by another regulator, and provides
transition for existing clearing agencies. This subsection
specifies core regulatory principles for derivatives clearing
organizations, including standards for minimum financial
resources, participant and product eligibility, risk
management, settlement procedures, safety of member or
participant funds and assets, rules and procedures for
defaults, rule enforcement, system safeguards, reporting,
recordkeeping, disclosure, information sharing, antitrust
considerations, governance arrangements, conflict of interest
mitigation, board composition, and legal risk. This subsection
also requires a derivatives clearing organization to provide
the CFTC with all information necessary for the CFTC to perform
its responsibilities.
Subsection (c). Legal certainty for identified banking
products
This subsection clarifies that the Federal banking
agencies, rather than the CFTC or SEC, retain regulatory
authority with respect to identified banking products, unless a
Federal banking agency, in consultation with the CFTC and SEC,
determines that a product has been structured as an identified
banking product for the purpose of evading the provisions of
the Commodity Exchange Act, Securities Act of 1933, or Exchange
Act.
Section 714. Public reporting of aggregate swap data
This section directs the CFTC (or a derivatives clearing
organization or swap repository designated by the CFTC) to make
available to the public, in a manner that does not disclose the
business transactions or market positions of any person,
aggregate data on swap trading volumes and positions.
Section 715. Swap repositories
This section describes the duties of a swap repository as
accepting, maintaining, and making available swap data as
prescribed by the CFTC; makes registration with the CFTC
voluntary for swap repositories; and subjects registered swap
repositories to CFTC inspection and examination. This section
also directs the CFTC and SEC to jointly adopt uniform rules
governing entities that register with the CFTC as swap
repositories and entities that register with the SEC as
security-based swap repositories, and authorizes the CFTC to
exempt from registration any swap repository subject to
comparable, comprehensive supervision or regulation by another
regulator.
Section 716. Reporting and recordkeeping
This section requires reporting and recordkeeping by any
person who enters into a swap that is not cleared through a
registered derivatives clearing organization or reported to a
swap repository.
Section 717. Registration and regulation of swap dealers and major swap
participants
This section requires swap dealers and major swap
participants to register with the CFTC, directs the CFTC and
SEC to jointly adopt rules to mitigate conflicts, and directs
the CFTC and SEC to jointly prescribe uniform rules for
entities that register with the CFTC as swap dealers or major
swap participants and entities that register with the SEC as
security-based swap dealers or major security-based swap
participants. This section also requires a registered swap
dealer or major swap participant to (1) meet such minimum
capital and margin requirements as the primary financial
regulatory agency (for banks) or CFTC and SEC (for nonbanks)
shall jointly prescribe; (2) meet reporting and recordkeeping
requirements; (3) conform with business conduct standards; (4)
conform with documentation and back office standards; and (5)
comply with requirements relating to position limits,
disclosure, conflicts of interest, and antitrust
considerations. The Commission may exempt swap dealers and
major swap participants from the margin requirement according
to certain criteria and pursuant to consultation with the
Financial Stability Oversight Council. If a party requests
margin for an exempt swap, the exemption shall not apply.
Regulators may permit the use of non-cash collateral to meet
margin requirements.
Section 718. Segregation of assets held as collateral in swap
transactions
For cleared swaps, this section requires that swap dealers,
futures commission merchants, and derivatives clearing
organizations segregate funds held to margin, guarantee, or
secure the obligations of a counterparty under a cleared swap
in a manner that protects their property. In addition,
counterparties to an un-cleared swap will be able to request
that any margin posted in the transaction be held by an
independent third party custodian. Assets must be segregated on
a non-discriminatory basis and may not be re-hypothecated.
Section 719. Conflicts of interest
This section also directs the CFTC to require futures
commission merchants and introducing brokers to implement
conflict-of-interest systems and procedures relating to
research activities and trading.
Section 720. Alternative swap execution facilities
This section defines alternative swap execution facility
and requires a facility for the trading of swaps to register
with the CFTC as an alternative swap execution facility
(``ASEF''), subject to certain criteria relating to deterrence
of abuses, trading procedures, and financial integrity of
transactions. This section also establishes core regulatory
principles for ASEFs relating to enforcement, anti-
manipulation, monitoring, information collection and
disclosure, position limits, emergency powers, recordkeeping
and reporting, antitrust considerations, and conflicts of
interest. This section directs the CFTC and SEC to jointly
prescribe rules governing the regulation of alternative swap
execution facilities, and authorizes the CFTC to exempt from
registration under this section an alternative swap execution
facility that is subject to comparable, comprehensive
supervision and regulation by another regulator.
Section 721. Derivatives transaction execution facilities and exempt
boards of trade
This section repeals the existing provisions of the
Commodity Exchange Act relating to derivatives transaction
execution facilities and exempt boards of trade.
Section 722. Designated contract markets
This section requires a board of trade, in order to
maintain designation as a contract market, to demonstrate that
it provides a competitive, open, and efficient market for
trading; has adequate financial, operational, and managerial
resources; and has established robust system safeguards to help
ensure resiliency.
Section 723. Margin
This section authorizes the CFTC to set margin levels for
registered entities.
Section 724. Position limits
This section authorizes the CFTC to establish aggregate
position limits across commodity contracts listed by designated
contract markets, commodity contracts traded on a foreign board
of trade that provides participants located in the United
States with direct access to its electronic trading and order
matching system, and swap contracts that perform or affect a
significant price discovery function with respect to regulated
markets.
Section 725. Enhanced authority over registered entities
This section enhances the CFTC's authority to establish
mechanisms for complying with regulatory principles and to
review and approve new contracts and rules for registered
entities.
Section 726. Foreign boards of trade
This section authorizes the CFTC to adopt rules and
regulations requiring registration by, and prescribing
registration requirements and procedures for, a foreign board
of trade that provides members or other participants located in
the United States direct access to the foreign board of trade's
electronic trading and order matching system. This section also
prohibits foreign boards of trade from providing members or
other participants located in the United States with direct
access to the electronic trading and order matching systems of
the foreign board of trade with respect to a contract that
settles against the price of a contract listed for trading on a
CFTC-registered entity unless the foreign board of trade meets,
in the CFTC's determination, certain standards of comparability
to the requirements applicable to U.S. boards of trade. This
section also provides legal certainty for certain contracts
traded on or through a foreign board of trade.
Section 727. Legal certainty for swaps
This section clarifies that no hybrid instrument sold to
any investor and no transaction between eligible contract
participants shall be void based solely on the failure of the
instrument or transaction to comply with statutory or
regulatory terms, conditions, or definitions.
Section 728. FDICIA amendments
Makes conforming amendments to the Federal Deposit
Insurance Corporation Improvement Act of 1991 (``FDICIA'') to
reflect that the definition of ``over-the-counter derivative
instrument'' under FDICIA no longer includes swaps or security-
based swaps.
Section 729. Primary enforcement authority
This section clarifies that the CFTC shall have primary
enforcement authority for all provisions of Subtitle A of this
Act, other than new Section 4s(e) of the Commodity Exchange Act
(as added by Section 717 of this Act, relating to capital and
margin requirements for swap dealers and major swap
participants), for which the primary financial regulatory
agency shall have exclusive enforcement authority with respect
to banks and branches or agencies of foreign banks that are
swap dealers or major swap participants. This section also
provides the primary financial regulatory agency with backstop
enforcement authority with respect to the nonprudential
requirements of the new Section 4s of the Commodity Exchange
Act (relating to registration and regulation of swap dealers
and major swap participants) if the CFTC does not initiate an
enforcement proceeding within 90 days of a written
recommendation by the primary financial regulatory agency.
Section 730. Enforcement
This section clarifies the enforcement authority of the
CFTC with respect to swaps and swap repositories, and of the
primary financial regulatory agency with respect to swaps, swap
dealers, major swap participants, swap repositories,
alternative swap execution facilities, and derivatives clearing
organizations.
Section 731. Retail commodity transactions
This section clarifies CFTC jurisdiction with respect to
certain retail commodity transactions.
Section 732. Large swap trader reporting
This section requires reporting and recordkeeping with
respect to large swap positions in the regulated markets.
Section 733. Other authority
This section clarifies that this title, unless otherwise
provided by its terms, does not divest any appropriate federal
banking agency, the CFTC, the SEC, or other federal or state
agency of any authority derived from any other applicable law.
Section 734. Antitrust
This section clarifies that nothing in this title shall be
construed to modify, impair, or supersede antitrust law.
Subtitle B--Regulation of Security-Based Swap Markets
Section 751. Definitions under the Securities Exchange Act of 1934
This section adds new definitions to the Securities
Exchange Act of 1934 and directs the CFTC and SEC to jointly
adopt uniform interpretations. The defined terms include
``security-based swap,'' ``security-based swap dealer,''
``security-based swap repository,'' ``mixed swap,'' and ``major
security-based swap participant.''
This section also establishes guidelines for joint CFTC and
SEC rulemaking authority under this Act. This section requires
that rules and regulations prescribed jointly under this Act by
the CFTC and SEC shall be uniform and shall treat functionally
or economically equivalent products similarly. This section
authorizes the CFTC and SEC to prescribe rules defining
``swap'' and ``security-based swap'' to prevent evasions of
this Act. This section also requires the CFTC and SEC to
prescribe joint rules in a timely manner and authorizes the
Financial Stability Oversight Council to resolve disputes if
the CFTC and SEC fail to jointly prescribe rules.
Section 752. Repeal of prohibition on regulation of security-based
swaps
This section repeals provisions enacted as part of the
Gramm-Leach-Bliley Act and the Commodity Futures Modernization
Act that prohibit the SEC from regulating security-based swaps.
Section 753. Amendments to the Securities Exchange Act of 1934
Subsection (a). Clearing for security-based swaps
This subsection requires clearing of all security-based
swaps that are accepted for clearing by a registered clearing
agency unless one of the parties to the swap qualifies for an
exemption. This subsection requires cleared security-based
swaps that are accepted for trading to be executed on a
registered national securities exchange or on a registered
alternative swap execution facility. The SEC may exempt a
security-based swap from the clearing and exchange trading
requirement if one of the counterparties to the swap is not a
security-based swap dealer or major swap participant and does
not meet the eligibility requirements of any clearing agency
that clears the swap. The SEC must consult the Financial
Stability Oversight Council before issuing an exemption.
Requires a party to a security-based swap to submit the swap
for clearing if a counterparty requests that the swap be
cleared and the swap is accepted for clearing by a registered
clearing agency.
This subsection requires clearing agencies to seek approval
from the SEC prior to clearing any group or category of
security-based swaps and directs the CFTC and SEC to jointly
adopt rules to further identify any group or category of
security-based swaps acceptable for clearing based on specified
criteria; authorizes the CFTC and SEC jointly to prescribe
rules or issue interpretations as necessary to prevent evasions
of section 3A of the Exchange Act; requires parties who enter
into non-cleared swaps to report such transactions to a swap
repository or the CFTC; and directs the SEC and CFTC to jointly
adopt uniform rules governing entities registered with the CFTC
as derivatives clearing organizations for swaps and with the
SEC as clearing agencies for security-based swaps.
Subsection (b). Alternative swap execution facilities
This subsection defines alternative swap execution facility
and requires facilities for the trading of security-based swaps
to register with the SEC as ASEFs, subject to certain criteria
relating to deterrence of abuses, trading procedures, and
financial integrity of transactions. This subsection also
establishes core regulatory principles for ASEFs relating to
enforcement, anti-manipulation, monitoring, information
collection and disclosure, position limits, emergency powers,
recordkeeping and reporting, antitrust considerations, and
conflicts of interest. This subsection directs the SEC and CFTC
to jointly prescribe rules governing the regulation of
alternative swap execution facilities, and authorizes the SEC
to exempt from registration under this subsection an
alternative swap execution facility that is subject to
comparable, comprehensive supervision and regulation by another
regulator.
Subsection (c). Trading in security-based swap agreements
This subsection prohibits parties who are not eligible
contract participants (as defined in the Commodity Exchange
Act) from effecting security-based swap transactions off of a
registered national securities exchange.
Subsection (d). Registration and regulation of swap dealers
and major swap participants
This subsection requires security-based swap dealers and
major security-based swap participants to register with the
SEC, and directs the SEC and CFTC to jointly prescribe uniform
rules for entities that register with the SEC as security-based
swap dealers or major security-based swap participants and
entities that register with the CFTC as swap dealers or major
swap participants. This subsection also requires security-based
swap dealers and major security-based swap participants to (1)
meet such minimum capital and margin requirements as the
primary financial regulatory agency (for banks) or CFTC and SEC
(for nonbanks) shall jointly prescribe; (2) meet reporting and
recordkeeping requirements; (3) conform with business conduct
standards; (4) conform with documentation and back office
standards; and (5) comply with requirements relating to
position limits, disclosure, conflicts of interest, and
antitrust considerations. The Commission may exempt security-
based swap dealers and major swap participants from the margin
requirement according to certain criteria and pursuant
consultation with the Financial Stability Oversight Council. If
a party requests margin for an exempt swap, the exemption shall
not apply. Regulators may permit the use of non-cash collateral
to meet margin requirements.
Subsection (e). Additions of security-based swaps to
certain enforcement provisions
This subsection adds security-based swaps to the Exchange
Act's list of financial instruments that a person may not use
to manipulate security prices.
Subsection (f). Rulemaking authority to prevent fraud,
manipulation, and deceptive conduct in security-
based swaps
This subsection prohibits fraudulent, manipulative, and
deceptive acts involving security-based swaps and security-
based swap agreements, and directs the SEC to prescribe rules
and regulations to define and prevent such conduct.
Subsection (g). Position limits and position accountability
for security-based swaps and large trader reporting
As a means to prevent fraud and manipulation, this
subsection authorizes the SEC to (1) establish limits on the
aggregate number or amount of positions that any person or
persons may hold across security-based swaps that perform or
affect a significant price discovery function with respect to
regulated markets; (2) exempt from such limits any person,
class of persons, transaction, or class of transactions; and
(3) direct a self-regulatory organization to adopt rules
relating to position limits for security-based swaps. This
subsection also requires reporting and recordkeeping with
respect to large security-based swap positions in regulated
markets.
Subsection (h). Public reporting and repositories for
security-based swap agreements
This subsection requires the SEC or its designee to make
available to the public, in a manner that does not disclose the
business transactions and market positions of any person,
aggregate data on security-based swap trading volumes and
positions. This subsection also describes the duties of a
security-based swap repository as accepting and maintaining
security-based swap data as prescribed by the SEC, makes SEC
registration for security-based swap repositories voluntary,
and subjects registered security-based swap repositories to SEC
inspection and examination. This subsection directs the SEC and
CFTC to jointly adopt uniform rules governing entities that
register with the SEC as security-based swap repositories and
entities that register with the CFTC as swap repositories and
authorizes the SEC to exempt from registration any security-
based swap repository subject to comparable, comprehensive
supervision or regulation by another regulator.
Section 754. Segregation of assets held as collateral in security-based
swap transactions
For cleared swaps, this section requires that security-
based swap dealers or clearing agencies segregate funds held to
margin, guarantee, or secure the obligations of a counterparty
in a manner that protects their property. In addition,
counterparties to an un-cleared swap will be able to request
that any margin posted in the transaction be held by an
independent third party custodian. Assets must be segregated on
a non-discriminatory bases and may not be re-hypothecated.
Section 755. Reporting and recordkeeping
This section requires reporting and recordkeeping by any
person who enters into a security-based swap that is not
cleared with a registered clearing agency or reported to a
security-based swap repository. This section also includes
security-based swaps within the scope of certain reporting
requirements under Sections 13 and 16 of the Exchange Act.
Section 756. State gaming and bucket shop laws
This section clarifies the applicability of certain state
laws to security-based swaps.
Section 757. Amendments to the Securities Act of 1933; treatment of
security-based swaps
This section amends the Securities Act of 1933 to include
security-based swaps within the definition of ``security.''
This section also amends Section 5 of the Securities Act of
1933 to prohibit offers to sell or purchase a security-based
swap without an effective registration statement to any person
other than an eligible contract participant (as defined in the
Commodity Exchange Act).
Section 758. Other authority
This section clarifies that this title, unless otherwise
provided by its terms, does not divest any appropriate federal
banking agency, the SEC, the CFTC, or other federal or state
agency of any authority derived from any other applicable law.
Section 758. Jurisdiction
This section clarifies that the SEC shall not have
authority to grant exemptions from the provisions of this Act,
except as expressly authorized by this Act; provides the SEC
with express authorization to use any authority granted under
subsection (a) to exempt any person or transaction from any
provision of this title that applies to such person or
transaction solely because a security-based swap is a security
under section 3(a).
Subtitle C--Other Provisions
Section 761. International harmonization
This section requires regulators to consult and coordinate
with international authorities on the establishment of
consistent standards for the regulation of swaps and security-
based swaps.
Section 762. Interagency cooperation
This section establishes a SEC-CFTC Joint Advisory
Committee to monitor and develop solutions emerging in the
swaps and security-based swaps markets, a SEC-CFTC Joint
Enforcement Task Force to improve market oversight, a SEC-CFTC-
Federal Reserve Trading and Markets Fellowship Program to
provide cross-training among agency staff about the interaction
between financial markets activity and the real economy, SEC-
CFTC cross-agency enforcement training and education, and
detailing of staff between the SEC and CFTC.
Section 763. Study and report on implementation
This section requires the GAO to conduct on study on the
implementation of this Act within one year of the date of
enactment.
Section 764. Recommendations for changes to insolvency laws
This section requires the SEC, CFTC, and FIRA to make
recommendations to Congress within 180 days of enactment
regarding Federal insolvency laws and their impact on various
swaps and security-based swaps activity.
Section 765. Effective date
This section specifies that this title shall become
effective 180 days after the date of enactment.
Title VIII--Payment, Clearing, and Settlement Supervision Act of 2009
Section 801. Short title
Section 802. Findings and purposes
This section describes the findings and purposes of the
Payment, Clearing, and Settlement Supervision Act of 2009. In
order to mitigate systemic risk in the financial system and
promote financial stability, this Act provides the Financial
Stability Oversight Council a role in identifying systemically
important financial market utilities and the Board of Governors
of the Federal Reserve System (``Board'') with an enhanced role
in supervising risk management standards for systemically
important financial market utilities and for systemically
important payment, clearing, and settlement activities
conducted by financial institutions.
Section 803. Definitions
Section 804. Designation of systemic importance
This section authorizes the Financial Stability Oversight
Council to designate financial market utilities or payment,
clearing, or settlement activities as systemically important,
and establishes procedures and criteria for making and
rescinding such a designation. Criteria for designation and
rescission of designation include the aggregate monetary value
of transactions processed and the effect that a failure of a
financial market utility or payment, clearing, or settlement
activity would have on counterparties and the financial system.
Section 805. Standards for systemically important financial market
utilities and payment, clearing, or settlement activities
This section authorizes the Board, in consultation with the
Financial Stability Oversight Council and the appropriate
supervisory agencies, to prescribe risk management standards
governing the operations of designated financial market
utilities and the conduct of designated payment, clearing, and
settlement activities by financial institutions. This section
also establishes the objectives, principles, and scope of such
standards.
Section 806. Operations of designated financial market utilities
This section authorizes a Federal Reserve bank to establish
and maintain an account for a designated financial market
utility and allows the Board to modify or provide an exemption
from reserve requirements that would otherwise be applicable to
the designated financial market utility. This section requires
a designated financial market utility to provide advance notice
of and obtain approval of material changes to its rules,
procedures, or operations.
Section 807. Examination and enforcement actions against designated
financial market utilities
This section requires the supervisory agency to conduct
safety and soundness examinations of a designated financial
market utility at least annually and authorizes the supervisory
agency to take enforcement actions against the utility. This
section also allows the Board to participate in examinations
by, and make recommendations to, other supervisors and
designates the Board as the supervisory agency for designated
financial market utilities that do not otherwise have a
supervisory agency. The Board is also authorized to take
enforcement actions against a designated financial market
utility if there is an imminent risk of substantial harm to
financial institutions or the broader financial system.
Section 808. Examination and enforcement actions against financial
institutions engaged in designated activities
This section authorizes the primary financial regulatory
agency to examine a financial institution engaged in designated
payment, clearing, or settlement activities and to enforce the
provisions of this Act and the rules prescribed by the Board
against such an institution. This section also requires the
Board to collaborate with the primary financial regulatory
agency to ensure consistent application of the Board's rules.
The Board is granted back-up authority to conduct examinations
and take enforcement actions if it has reasonable cause to
believe a violation of its rules or of this Act has occurred.
Section 809. Requests for information, reports, or records
This section authorizes the Financial Stability Oversight
Council to collect information from financial market utilities
and financial institutions engaged in payment, clearing, or
settlement activities in order to assess systemic importance.
Upon a designation by the Financial Stability Oversight
Council, the Board may require submission of reports or data by
systemically important financial market utilities or financial
institutions engaged in activities designated to be
systemically important. This section also facilitates sharing
of relevant information and coordination among financial
regulators, with protections for confidential information.
Section 810. Rulemaking
This section authorizes the Board and the Financial
Stability Oversight Council to prescribe such rules and issue
such orders as may be necessary to administer and carry out the
purposes of this title and prevent evasions thereof.
Section 811. Other authority
This section clarifies that this Act, unless otherwise
provided by its terms, does not divest any appropriate
financial regulatory agency, supervisory agency, or other
Federal or State agency of any authority derived from any other
applicable law.
Section 812. Effective date
This section specifies that this Act shall be effective as
of the date of enactment.
Title IX--Investor Protections
Subtitle A
Section 911. Investor Advisory Committee established
Section 911 establishes within the SEC the Investor
Advisory Committee to assist the SEC by advising and consulting
on regulatory priorities; issues relating to securities,
trading, fee structures and the effectiveness of disclosures;
investor protection; and initiatives to promote investor
confidence. The Committee shall be composed of the Investor
Advocate, a representative of state securities commissions
because of the important work that States have performed in
protecting investors, a representative of the interests of
senior citizens who are sometimes targeted for securities
frauds, and between 12 and 22 members who represent the
interests of individual investors, institutional investors, and
pension fund investors.
The Committee shall elect from among themselves a Chairman,
Vice Chairman, Secretary, and Assistant Secretary, each of whom
shall serve a 3 year term. The Committee shall meet at least
twice per year. The SEC shall provide the Committee with the
staff necessary to fulfill its mission. The SEC must publicly
respond to Committee findings and recommendations by assessing
them and disclosing any action the SEC intends to take. It is
expected that the responses will be made shortly after the
Committee acts.
In June of 2009, the SEC formed an Investor Advisory
Committee. This legislation gives the Investor Advisory
Committee a statutory foundation and sets congressional
prerogatives for the Committee's composition and function.
The proposal for this Committee was included in the
Treasury Department legislative proposal for financial
reform.\162\ AARP supports the statutory establishment of this
Committee. On November 19, 2009, the AARP wrote in a letter to
Senators Dodd and Shelby, ``AARP also supports additional
powers granted to the SEC to strengthen its work on behalf of
investors, including explicit authority to establish an
Investor Advisory Committee.''\163\
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\162\FACT SHEET: ADMINISTRATION'S REGULATORY REFORM AGENDA MOVES
FORWARD; Legislation for Strengthening Investor Protection Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 10,
2009, www.financialstability.gov.
\163\AARP, letter to Senators Dodd and Shelby, November 19, 2009.
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Section 912. Clarification of authority of the commission to engage in
consumer testing
Section 912 clarifies the SEC's authority to gather
information from and communicate with investors and engage in
such temporary programs as the SEC determines are in the public
interest for the purpose of evaluating any rule or program of
the SEC.
In the past, the SEC has carried out consumer testing
programs, but there have been questions of the legality of this
practice. This legislative language gives clear authority to
the SEC for these activities.
This proposal is included in the Treasury Department's
legislative language for financial reform\164\. The AARP told
the Committee that it ``supports the explicit authority granted
to the SEC to test rules or programs by gathering information
and communicating with investors and other members of the
public. This type of testing has the very real potential to
improve the clarity and usefulness of the disclosures that our
securities regulatory scheme relies upon.''\165\ Mr. James
Hamilton, Principal Analyst, CCH Federal Securities Law
Reporter has said ``The SEC can better evaluate the
effectiveness of investor disclosures if it can meaningfully
engage in consumer testing of those disclosures. The SEC should
be better enabled to engage in field testing, consumer outreach
and testing of disclosures to individual investors, including
by providing budgetary support for those activities.''\166\
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\164\FACT SHEET: ADMINISTRATION'S REGULATORY REFORM AGENDA MOVES
FORWARD; Legislation for Strengthening Investor Protection Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 10,
2009, www.financialstability.gov.
\165\AARP, letter to Senators Dodd and Shelby, November 19, 2009.
\166\Obama Reform Proposal Would Enhance SEC Investor Protection
Role, Jim Hamilton's World of Securities Regulation,
jimhamiltonblog.blogspot.com, June 17, 2009.
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Section 913. Study and rulemaking regarding obligations of brokers,
dealers, and investment advisers
Section 913 was authored by Senators Johnson and Crapo. It
directs the SEC to conduct a study of the effectiveness of
existing legal or regulatory standards of care for brokers,
dealers, and investment advisers for providing personalized
investment advice and recommendations about securities to
retail customers imposed by the SEC and FINRA, and whether
there are legal or regulatory gaps or overlap in legal or
regulatory standards in the protection of retail customers. The
section also requires the SEC to issue a report within one year
that considers public input. If this study identifies any gaps
or overlap in the legal or regulatory standards in the
protection of retail customers relating to the standards of
care for brokers, dealers, and investment advisers, the SEC
shall commence a rulemaking within two years to address such
regulatory gaps and overlap that can be addressed by rule,
using its existing authority under the Securities Exchange Act
of 1934 and the Investment Advisers Act of 1940.
Section 914. Creation of Office of the Investor Advocate
Section 914 was authored by Senator Akaka. Section 914
creates the Office of the Investor Advocate within the
Securities and Exchange Commission (SEC). The Committee
believes it is necessary to create an office of the Investor
Advocate within the SEC to strengthen the institution and
ensure that the interests of retail investors are better
represented. The Investor Advocate is tasked with assisting
retail investors to resolve significant problems with the SEC
or the self-regulatory organizations (SROs). The Investor
Advocate's mission includes identifying areas where investors
would benefit from changes in SEC or SRO policies and problems
that investors have with financial service providers and
investment products. The Investor Advocate will recommend
policy changes to the SEC and Congress in the interests of
investors. The Taxpayer Advocate within the Internal Revenue
Service has contributed significantly to the improvement of
policies that have benefitted taxpayers. A similar office in
the SEC has a tremendous potential to similarly benefit retail
investors. The Investor Advocate, with its independent
reporting lines, would help to ensure that the interests of
retail investors are built into rulemaking proposals from the
outset and that agency priorities reflect the issues that
confront average investors. The Investor Advocate will increase
transparency and accountability at the SEC and be equipped to
act in response to feedback from investors and potentially
avoid situations such as the mishandling of tips that could
have exposed Ponzi schemes much earlier. The Investor Advocate,
and staff of the Office of the Investor Advocate, shall
maintain the same level of confidentiality for any document or
information made available under this section as is required of
any member, officer, or employee of the SEC. In this regard,
the Investor Advocate and staff in the Office of the Investor
Advocate are subject to the same statutory and regulatory
restrictions on, and applicable penalties for, the unauthorized
disclosure or use of any nonpublic information that apply to
any member, officer, or employee of the SEC.
Section 915. Streamlining of filing procedures for self-regulatory
organizations
Section 915 requires the SEC to approve a proposed SRO rule
or institute a proceeding to consider whether the rule should
be disapproved within 45 days. The SEC can extend this period
by 45 days if appropriate. If the SEC does not approve the rule
within this period then it must provide a hearing within 180
days of the rule proposal publication. The SEC must approve or
disapprove the rule during this same period, or it can extend
this period by 60 days if necessary. If the SEC does not follow
these time restrictions, the rule is deemed to have been
approved. The SEC has 7 days after the receipt of the proposal
to notify the SRO if the proposed rule change does not comply
with the rules of the SEC relating to the required form of a
proposed rule change.
The Committee recognizes that in the modern securities
markets it is important that the SEC operate efficiently and
responsively. The Committee has heard concerns about current
SEC processes for action on rule changes by exchanges and other
self-regulatory organizations.
The Committee expects that the changes will encourage the
SEC to employ a more transparent and rapid process for
consideration of rule changes.
Nothing in the Section diminishes the SEC's authority to
reject an improperly filed rule, disapprove a rule that is not
consistent with the Exchange Act, or diminishes the applicable
public notice and comment period.
Nasdaq OMX, NYSE Euronext, International Securities
Exchange and Chicago Board Options Exchange have written
jointly by letter dated November 24, 2009 in strong support of
this provision because ``it would streamline the Securities and
Exchange Commission's (SEC) process for making a determination
on an exchange rule proposal.'' They explained, ``As Self
Regulatory Organizations (SROs), we are subject to the
regulatory authority of the SEC, which includes the requirement
that we submit all proposed rule changes to the SEC for
approval. Although the SEC has made progress in increasing the
number of rule proposals that may be submitted for immediate
effectiveness, the process that rule proposals that are not
subject to immediate effectiveness must undergo remains a point
of frustration for SROs. The current process enables the SEC to
use internal interpretations to avoid what should be reasonable
timelines to move rule filings toward a determination of
approval or denial. This process not only delays transparency
and public input, it provides a significant competitive
advantage to our less regulated competitors, which do not have
to seek regulatory approval before changing their rules.''
Section 916. Study regarding financial literacy among investors
Section 916 was authored by Senator Akaka. This Section
directs the SEC to study and issue a report on the existing
level of financial literacy among retail investors. The SEC
will have to develop an investor financial literacy strategy.
The strategy is intended to bring about positive behavioral
change in investors. The study will identify: (1) the existing
level of financial literacy among retail investors; (2) methods
to improve the timing, content, and format of disclosures to
investors with respect to financial intermediaries, investment
products, and investment services; (3) the most useful and
understandable relevant information that retail investors need
to make informed financial decisions; (4) methods to increase
the transparency of expenses and conflicts of interests in
transactions involving investment services and products; (5)
the most effective existing private and public efforts to
educate investors; and (6) in consultation with the Financial
Literacy and Education Commission, a strategy to increase the
financial literacy of investors in order to bring about a
positive change in investor behavior.
The AARP also supported the study of financial literacy in
a letter to Senators Dodd and Shelby.\167\
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\167\AARP, letter to Senators Dodd and Shelby, November 19, 2009.
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Section 917. Study regarding mutual fund advertising
Section 917 directs the GAO to conduct a study and issue a
report on mutual fund advertising to examine: (1) existing and
proposed regulatory requirements for open-end investment
company advertisements; (2) current marketing practices for the
sale of open-end investment company shares, including the use
of past performance data, funds that have merged, and incubator
funds; (3) the impact of such advertising on consumers; and (4)
recommendations to improve investor protections in mutual fund
advertising and additional information necessary to ensure that
investors can make informed financial decisions when purchasing
shares.
Section 918. Clarification of commission authority to require investor
disclosures before purchase of investment products and services
Section 918 was authored by Senator Akaka. Section 918
clarifies the SEC's authority to require investor disclosures
before the purchase of investment company shares. This section
will give the SEC the authority to require broker-dealers to
disclose to clients their compensation for sales of open- and
closed-end mutual funds. The Committee believes that investors
must be provided with relevant, meaningful, and timely
disclosures about financial products and services from which
they can make better informed investment decisions. The
Committee encourages the SEC to use the consumer testing
authorized under Section 912 and the study on financial
literacy under Section 916 to inform its scope of disclosures.
Mr. James Hamilton, Principal Analyst, CCH Federal
Securities Law Reporter, said ``legislation should authorize
the SEC to require that certain disclosures (including a
summary prospectus) be provided to investors at or before the
point of sale, if the SEC finds that such disclosures would
improve investor understanding of the particular financial
products, and their costs and risks. Currently, most
prospectuses (including the mutual fund summary prospectus) are
delivered with the confirmation of sale, after the sale has
taken place. Without slowing the pace of transactions in modem
capital markets, the SEC should require that adequate
information is given to investor to make informed investment
decisions.''\168\
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\168\Obama Administration Would Enhance SEC's Investor Protection
Role, Mr. James Hamilton, CCH Financial Crisis Newsletter, June 18,
2009, www.financialcrisisupdate.com.
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Mr. Travis Plunkett, Legislative Director of the Consumer
Federation of America, also supports this provision. In
testimony for the House Financial Services Committee, he wrote
``we also strongly support requiring pre-sale disclosure to
assist mutual fund investors to make more informed investment
decisions. While mutual funds are subject to more robust
disclosure requirements than many competing investment products
and services, the disclosures typically do not arrive until
three days after the sale. This makes them essentially useless
in helping investors to assess the risks and costs of the fund,
as well as the uses for which it may be most
appropriate.''\169\ AARP also supports this provision.\170\ The
Committee encourages that Securities and Exchange Commission to
use the consumer testing authorized under Section 912 and the
study on financial literacy under Section 916 to inform its
scope of disclosures.
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\169\Community and Consumer Advocates' Perspectives on the Obama
Administration's Financial Regulatory Reform Proposals: Testimony
before the U.S. House Committee on Financial Services, 111th Congress,
1st session, p.24 (2009) (Testimony of Mr. Travis Plunkett).
\170\AARP, letter to Senators Dodd and Shelby, November 19, 2009.
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Section 919. Study on conflicts of interest
Section 919 directs the GAO to conduct a study and make
recommendations regarding potential conflicts of interest
between securities underwriting and securities analysis
functions within firms. In this study, the GAO will consider
potential harm to investors of these conflicts, the nature and
benefit of the undertakings to which the firms agreed as part
of the Global Settlement, whether any of these undertakings
should be codified, and whether to recommend regulatory or
legislative measures to mitigate harm to investors caused by
these conflicts of interest. The GAO will consult with the SEC,
FINRA, investor advocates, retail investors, institutional
investors, academics, and State securities officials in
performing this study. This issue has been a subject of public
concern for many years. On March 15, 2010, the U.S. District
Court in New York rejected a proposal by the SEC and 12
securities firms to change the legal settlement put in place
with the Global Research Analyst Settlements to end abuses on
Wall Street that would have allowed employees in investment-
banking and research departments at Wall Street firms to
``communicate with each other . . . outside of the presence''
of lawyers or compliance-department officials responsible for
policing employee conduct--an activity strictly prohibited by
the settlement. The 2003 Global Settlement resolved a major
securities scandal, in which 10 of the largest securities firms
and two individual analysts were charged with issuing
misleading or fraudulent analyst recommendations and fines of
$1.4 billion were assessed.
Title V of the Sarbanes-Oxley Act of 2002 (P.L. 107-204)
addressed aspects of this issue by amending the Securities
Exchange Act of 1934 to require the SEC, or upon the
authorization and direction of the SEC, a registered securities
association or national securities exchange, to adopt rules
reasonably designed to address conflicts of interest that can
arise when securities analysts recommend equity securities in
research reports and public appearances.
Section 919A. Study on improved access to information on investment
advisers and broker-dealers
Senator Brown (OH) authored Section 919A. This Section
directs the SEC to study and make recommendations on ways to
improve the access of investors to registration information
about registered and previously registered investment advisers,
associated persons of investment advisers, brokers and dealers
and their associated persons on the existing Central
Registration Depository and Investment Adviser Registration
Depository systems, as well as identify additional information
that should be made publicly available.
Section 919B. Study on financial planners and the use of financial
designations
Senator Kohl authored Section 919B. This Section directs
the GAO to conduct a study to evaluate and make recommendations
on the effectiveness of State and Federal regulations to
protect consumers from misleading financial advisor
designations; current State and Federal oversight structure and
regulations for financial planners; and legal or regulatory
gaps in the regulation of financial planners and other
individuals who provide or offer to provide financial planning
services to consumers.
Senator Kohl has said that ``Financial planners provide
advice on a wide range of issues, including home ownership,
saving for college and selecting appropriate investment
products. Because this advice will have a lasting impact on the
financial health of the consumer, it is important that the
service provider meets certain standards. Currently, different
states' laws govern financial planners, with no standard code
of conduct, training requirements or conflict of interest
disclosure requirements. Additionally, there is little
accountability for financial planners that take advantage of
consumers. Both consumers and financial planners will benefit
from standardizing rules and increased oversight at the federal
level.''\171\ Marilyn Mohrman-Gillis, Managing Director, Public
Policy, Certified Financial Planner Board of Standards, Inc.
said ``we recognize that the study is certainly a first step in
Congress recognizing the need for reform.''
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\171\Senator Kohl, letter to Senator Dodd, February 22, 2010.
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Subtitle B
Section 921. Authority to issue rules to restrict mandatory predispute
arbitration
Section 921 gives the SEC the authority to conduct a
rulemaking to prohibit, or impose conditions or limitations on
the use of, agreements that require customers or clients of any
broker, dealer, or municipal securities dealer to arbitrate any
dispute between them. This provision was included in the
Treasury Department's legislative proposal.\172\
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\172\FACT SHEET: ADMINISTRATION'S REGULATORY REFORM AGENDA MOVES
FORWARD; Legislation for Strengthening Investor Protection Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 10,
2009, www.financialstability.gov.
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There have been concerns over the past several years that
mandatory pre-dispute arbitration is unfair to the investors.
In a letter to Chairman Dodd and Ranking Member Shelby, AARP
expressed support for this provision. In listing some of the
problems with mandatory pre-dispute arbitration, the letter
identified ``high up-front costs; limited access to documents
and other key information; limited knowledge upon which to base
the choice of arbitrator; the absence of a requirement that
arbitrators follow the law or issue written decisions; and
extremely limited grounds for appeal.''\173\
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\173\AARP, letter to Senators Dodd and Shelby, November 19, 2009.
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The North American Securities Administrators Association
also supports this provision, stating in testimony that a
``major step toward improving the integrity of the arbitration
system is the removal of the mandatory industry arbitrator.
This mandatory industry arbitrator, with their industry ties,
automatically puts the investor at an unfair
disadvantage.''\174\ The Consumer Federation of America,\175\
AARP,\176\ and the Public Investors Arbitration Bar Association
support this approach.\177\
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\174\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.18
(2009) (Testimony of Mr. Fred Joseph).
\175\Consumer Federation of America (November 10, 2009), ``CFA
Applauds Introduction of Senator Dodd's Financial Reform Package,''
Press release, www.consumerfed.org.
\176\AARP, letter to Senators Dodd and Shelby, November 19, 2009.
\177\The following article references the Public Investors
Arbitration Bar Association's support for this provision: ``Death Knell
For Mandatory Arbitration,'' Helen Kearney, On Wall Street, August 1,
2009.
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Section 922. Whistleblower protection
The Whistleblower Program, established and administered by
the Securities and Exchange Commission, is intended to provide
monetary rewards to those who contribute ``original
information'' that lead to recoveries of monetary sanctions of
$1,000,000 or more in criminal and civil proceedings. The
genesis of the program is found in President Obama's June 2009
financial regulatory reform proposal.\178\ A similar provision
was included in the House of Representatives financial reform
bill (H.R. 4173).
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\178\Fact Sheet: Administration's Regulatory Reform Agenda Moves
Forward; Legislation for Strengthening Investor Protection Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 10,
2009. Available at http://www.financialstability.gov.
---------------------------------------------------------------------------
The Whistleblower Program aims 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. In a
testimony for the Senate Banking Committee, Certified Fraud
Examiner and Madoff whistleblower Harry Markopolos testified in
support of creating a strong Whistleblower Program. He cited
statistics showing the efficiency of Whistleblower Programs:
``whistleblower tips detected 54.1% of uncovered fraud schemes
in public companies. External auditors, and the SEC exam teams
would certainly be considered external auditors, detected a
mere 4.1% of uncovered fraud schemes. Whistleblower tips were
13 times more effective than external audits, hence my
recommendation to the SEC to encourage the submission of
whistleblower tips.'' \179\ In his letter to Senator Dodd, SEC
Inspector General David Kotz also recommended a similar
Whistleblower Program.\180\
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\179\``Oversight of the SEC's Failure to Identify the Bernard L.
Madoff Ponzi Scheme and How to Improve SEC Performance: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs'', 111th Congress, 1st session, p.33 (2009) (Testimony of Mr.
Harry Markopolos).
\180\Inspector General H. David Kotz, letter to Senator Dodd,
October 29, 2009.
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Recognizing that whistleblowers often face the difficult
choice between telling the truth and the risk of committing
``career suicide'', the program provides for amply rewarding
whistleblower(s), with between 10% and 30% of any monetary
sanctions that are collected based on the ``original
information'' offered by the whistleblower. The program is
modeled after a successful IRS Whistleblower Program enacted
into law in 2006. The reformed IRS program, which, too, has a
similar minimum-maximum award levels and an appeals
process,\181\ is credited to have reinvigorated the earlier,
largely ineffective, IRS Whistleblower Program. The Committee
feels the critical component of the Whistleblower Program is
the minimum payout that any individual could look towards in
determining whether to take the enormous risk of blowing the
whistle in calling attention to fraud.
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\181\Like the IRS program, the new SEC Whistleblower Program
provides for an appeals process, the appropriate court of appeals will
review the determination made by the Commission in accordance with
section 706 of title 5 of U.S. Code (i.e., abuse of discretion).
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We also note a recent report of the current SEC insider-
trading Whistleblower Program by the Office of Inspector
General of SEC. Since the inception of the program in 1989,
there have been a total of only seven payouts to five
whistleblowers for a meager total of $159,537.\182\ In the
report, the Inspector General recommends several important
guidelines that any current or future SEC Whistleblower
Programs should follow, including: development of specific
criteria for bounty awards (including a provision to award
whistleblowers that partly rely upon public information),
development of tips and complaints tracking systems,
incorporating best practices from DOJ and IRS's Whistleblower
Programs, and establishment of a timeframe for the new
policies.
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\182\``Assessment of the SEC's Bounty Program'', Office of
Inspector General, U.S. Securities and Exchange Commission, Report No.
474. March 29, 2010.
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``Original information'' is defined as information that is
derived from the independent analysis or knowledge of the
whistleblower, and is not derived from an allegation in court
or government reports, and is not exclusively from news media.
In circumstances when bits and pieces of the whistleblower's
information were known to the media prior to the emergence of
the whistleblower, and that for the purposes of the SEC
enforcement\183\ the critical components of the information was
supplied by the whistleblower, the intent of the Committee is
to require the SEC to reward such person(s) in accordance with
the degree of assistance that was provided. The rewards are to
be from the Investor Protection Fund, which receives funds from
sanctions collected based on civil enforcement and from other
funds within SEC that are otherwise not distributed to
investors (i.e., unused disgorgement funds). Whenever a
whistleblower or whistleblowers tip leads the SEC to collect
sanctions and penalties that are determined to be distributed
to the victims of the fraud, the intent of the Committee is to
reward the whistleblower prior or at the same time as paying
such victims, recognizing that were it not for the
whistleblower's actions, there would have been no discovery of
the harm to the investors and no collection of any sanctions
for their benefit.
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\183\Same would apply to cases when SEC forwards criminal cases to
DOJ that lead to penalties and sanctions.
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The SEC has discretion in determining the amount and
whether or not a whistleblower is eligible to be awarded. In
cases when whistleblowers feel that the SEC had abused its
discretion in determining the amount of the award, they have
the right to appeal, within 30 days of the decision to a court
of appeals. The court is to review the determination in
accordance with section 706 of title 5 of U.S. Code. The
Committee feels that this review process will significantly
contribute to make the program reliable for persons who are
contemplating whether or not to blow the whistle on fraud. It
will add to the notion of enforceable payout. The Committee,
having heard from several parties involved in whistleblower
related cases, has determined that enforceability and
relatively predictable level of payout will go a long way to
motivate potential whistleblowers to come forward and help the
Government identify and prosecute fraudsters. Whistleblowers
who are employees of an appropriate regulatory agency, DOJ,
SROs, PCAOB, accountants in certain circumstances, or a law
enforcement organization are generally not eligible for an
award. Also not eligible are whistleblowers who are convicted
of a criminal violation related to the case at hand.
The Committee intends for this program to be used actively
with ample rewards to promote the integrity of the financial
markets.
The program also requires the SEC to annually report back
to Congress, among other things, with details regarding the
number and types of awards granted. It also provides for
various protections for whistleblowers, specifically barring
employers to discharge, demote, suspend, threaten, harass
directly or indirectly, or in any other manner discriminate.
The provision also makes it unlawful to knowingly and willfully
make any false, fictitious or fraudulent statement or
representation, or use any false writing or document knowing
the writing or document contains any false, fictitious, or
fraudulent statement or entry. Following the enactment of the
Act, the SEC will have 270 days to issue final regulations
implementing the provisions of the Act.
Section 923. Conforming amendments for whistleblower protection
Section 923. contains conforming amendments for whistleblower
protection.
Section 924. Implementation and transition provisions for whistleblower
protection
Section 924 contains implementation and transition
provisions for whistleblower provisions. The section directs
the SEC to issue final regulations implementing the provisions
of section 21F of the Securities Exchange Act of 1934 within
270 days within enactment of the Act.
Section 925. Collateral bars
Section 925 gives the SEC the authority to bar individuals
from being associated with various registered securities market
participants after violating the law while associated in only
one area. This provision is included in the Treasury
Department's legislative proposal.\184\ The Committee finds
that this provision is necessary because, under current rules,
individuals could be barred from one registered entity for
violations, such as fraud, but then work in another industry
where they could prey upon other investors.
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\184\FACT SHEET: ADMINISTRATION'S REGULATORY REFORM AGENDA MOVES
FORWARD; Legislation for Strengthening Investor Protection Delivered to
Capitol Hill, U.S. Department of the Treasury, Press Release, July 10,
2009, www.financialstability.gov.
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Section 926. Authority of state regulators over regulation D offerings
Section 926 restores certain authority of States over
Regulation D offerings. This provision will give the States the
authority over certain securities sales that are not subject to
the '33 Act requirements due to their size and scope, as
determined by the SEC.
The North American Securities Administrators Association
described why this provision is needed: ``These offerings also
enjoy an exemption from registration under federal securities
law, so they receive virtually no regulatory scrutiny even
where the promoters or broker-dealers have a criminal or
disciplinary history. As a result, Rule 506 offerings have
become the favorite vehicle under Regulation D, and many of
them are fraudulent. Although Congress preserved the states'
authority to take enforcement actions for fraud in the offer
and sale of all `covered' securities, including Rule 506
offerings, this power is no substitute for a state's ability to
scrutinize offerings for signs of potential abuse and to ensure
that disclosure is adequate before harm is done to
investors.''\185\ In light of the growing popularity of Rule
506 offerings and the expansive reading of the exemption given
by certain courts, NASAA believes the time has come for
Congress to reinstate state regulatory oversight of all Rule
506 offerings by repealing Subsection 18(b)4(D) of the
Securities Act of 1933.''\186\
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\185\North American Securities Administrators Association, Inc.,
letter to Chairman Dodd and Ranking Member Shelby, November 17, 2009.
\186\Pro-Investor Legislative Agenda for the 111th Congress, North
American Securities Administrators Association, January, 2009,
www.nasaa.org.
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The Committee also heard from interested parties stating
that the SEC is adequately capable of reviewing these filings,
however we note, in the words of Jennifer Johnson, that ``the
SEC simply does not have the resources, even if it had the
will, to police smaller private placements. State regulators,
on the other hand, as ``local cops on the beat,'' are well
positioned to fill this regulatory gap. While states currently
have enforcement powers under NSMIA . . . they may not become
aware of serious problems involving Rule 506 offerings until
after injured investors contact them. While states may be able
to prosecute the perpetrators of fraud, they cannot
prophylactically protect future victims.''\187\
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\187\Johnson, Jennifer, 2010. ``Private Placements: A regulatory
Black Hole''. Delaware Journal of Corporate Law. Vol. 34, p. 195.
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The Committee is concerned to protect investors who, under
current regulatory scheme and practice, lack regulatory
protections. There is a particular concern to protect investors
from recidivist perpetrators of securities fraud. This Section
does not resolve other current issues involving the SEC's
administration of Regulation D, several of which are
highlighted in the SEC Office of Inspector General audit report
on ``Regulation D Exemption Process,'' March 31, 2009 (e.g.,
the SEC ``should develop a process to assess and better ensure
issuers' compliance with Regulation D and take appropriate
action when . . . [it] finds companies have materially misused
the Regulation D exemptions'').
Section 927. Equal treatment of self-regulatory organization rules
Section 927 provides equal treatment for the rules of all
SROs under Section 29(a), which voids any condition,
stipulation, or provision binding any person to waive
compliance with any provision of the Exchange Act, any rule or
regulation thereunder, or any rule of an exchange.
Section 928. Clarification that Section 205 of the Investment Advisers
Act of 1940 does not apply to state-registered advisers
Section 928 clarifies that Sec. 205 of the Advisers Act
(performance fees and advisory contracts) does not apply to
state-registered investment advisors. This is a clarification
from the National Securities Markets Improvement Act that these
restrictions on investment adviser contracts do not apply to
state-registered advisers.
Section 929. Unlawful margin lending
Under previous law, it was unlawful for any member of a
national securities exchange or any broker or dealer to provide
margin lending to or for any customer on any non-exempt
security unless the loan met margin regulations provided for in
Chapter 2B of Title 15 of the U.S. Code and was properly
collateralized. Section 929 provides that either of these two
infractions is unlawful by itself.
Section 929A. Protection for employees of subsidiaries and affiliates
of publicly traded companies
Amends Section 806 of the Sarbanes-Oxley Act of 2002 to
make clear that subsidiaries and affiliates of issuers may not
retaliate against whistleblowers, eliminating a defense often
raised by issuers in actions brought by whistleblowers. Section
806 of the Sarbanes-Oxley Act creates protections for
whistleblowers who report securities fraud and other
violations. The language of the statute may be read as
providing a remedy only for retaliation by the issuer, and not
by subsidiaries of an issuer. This clarification would
eliminate a defense now raised in a substantial number of
actions brought by whistleblowers under the statute.
Section 929B. Fair Fund amendments
Amends Section 308 of the Sarbanes-Oxley Act of 2002 to
permit the SEC use penalties obtained from a defendant for the
benefit of victims even if the SEC does not obtain disgorgement
from the defendant (e.g., because defendant did not benefit
from its securities law violation that nonetheless harmed
investors). Under the Fair Fund provisions of the Sarbanes-
Oxley Act, the SEC must obtain disgorgement from a defendant
before the SEC can use penalties obtained from the defendant in
a Fair Fund for the benefit of victims of the defendant's
violation of the securities laws, or a rule or regulation
thereunder. This section would revise the Fair Fund provisions
to permit the SEC to use penalties obtained from a defendant
for the benefit of victims even if the SEC does not obtain an
order requiring the defendant to pay disgorgement. In some
cases, a defendant may engage in a securities law violation
that harms investors, but the SEC cannot obtain disgorgement
from the defendant because, for example, the defendant did not
benefit from the violation.
Section 929C. Increasing the borrowing limit on treasury loans
Section 929C updates Securities Investor Protection Act,
including borrowing of funds, distinction between securities
and cash insurance, portfolio margin, and liquidation. This
line of credit has not been increased since SIPA was enacted in
1970. SEC staff believes an increase is necessary to provide
the Securities Investor Protection Corporation (SIPC) with
sufficient resources in the event of the failure of a large
broker-dealer. This line of credit is used in the event that
SIPC asks for a loan from the SEC and the SEC determines that
such a loan is necessary ``for the protection of customers of
brokers or dealers and the maintenance of confidence in the
United States securities markets.'' SEC staff also support
eliminating the distinction in the statute between claims for
cash and claims for securities. Section 21 of the Glass-
Steagall Act, 12 USC 378, prevents broker-dealers (and any
entity other than a bank) from accepting deposits. Staff
believes that the distinction between claims for cash and
claims for securities has become blurred in recent years and
that the distinction can be confusing to customers.
Subtitle C
Section 931. Findings
This section contains Congressional findings that credit
ratings are systemically important; relied upon by individual
and institutional investors and regulators; and central to
capital formation, investor confidence and economic efficiency.
Credit rating agencies play a gatekeeper role in financial
markets that justifies the same level of oversight and
accountability that applies to securities analysts, auditors,
and investment banks. Inaccurate ratings, generated in part by
conflicts of interest in the process of rating structured
financial products, contributed to the mismanagement of risk by
large financial institutions and investors, which set the stage
for global financial panic.
Section 932. Enhanced regulation, accountability, and transparency of
nationally recognized statistical ratings organizations
This section provides for enhanced regulation of nationally
recognized statistical ratings organizations (NRSROs), greater
accountability on the part of NRSROs that fail to produce
accurate ratings, and more disclosure to permit investors to
better understand credit ratings and their limitations. The
section builds upon the principles of the Credit Rating Agency
Reform Act of 2006, which introduced the NRSRO designation and
sought to improve ratings performance through a combination of
regulatory oversight and competition.
Enhanced Regulation
Paragraph (1) of Section 932 provides that each NRSRO shall
establish, maintain, enforce, and document an effective
internal control structure governing the implementation of and
adherence to policies, procedures, and methodologies for
determining credit ratings, taking into consideration such
factors as the SEC may prescribe, by rule. This provision also
calls for an annual report containing an assessment of the
effectiveness and a CEO attestation on the internal controls.
In support of this provision, Ms. Rita Bolger, Senior Vice
President and Associate General Counsel of Standard & Poor's,
wrote in testimony for the Senate Banking Committee that ``a
regulatory regime should provide for effective oversight of
registered agencies' compliance with their policies and
procedures through robust, periodic inspections. Such oversight
must avoid interfering in the analytical process and
methodologies, and refrain from second-guessing rating
opinions. External interference in ratings analytics undermines
investor confidence in the independence of the rating opinion
and heightens moral hazard risk in influencing a rating
outcome.''\188\
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\188\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p. 11
(2009) (Testimony of Ms. Rita Bolger).
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Section 932 also gives the SEC the authority to fine an
NRSRO for violations of law or regulation. Under previous law,
the SEC could not fine NRSROs, but could only censure, place
limitations on the activities, functions, or operations of,
suspend for a period not exceeding 12 months, or revoke the
registration of any NRSRO. Under this provision the SEC retains
these abilities. Lynn Turner, former Chief Accountant of the
SEC, supports this provision. He wrote in testimony for the
Senate Banking Committee that ``the SEC should be given the
authority to fine the agencies or their employees who fail to
adequately protect investors.''\189\
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\189\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p. 11 (2009)
(Testimony of Mr. Lynn Turner).
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Section 932 attempts to eliminate the effect of the
inherent conflict of interest in the issuer-pays model of the
credit rating industry. Under this model, issuers of debt have
the incentive to use the rating agency that provides the
highest rating. A conflict of interest thus arises because
rating agencies want to provide the highest rating to keep the
issuer's business and are less willing to publish a lower
rating. The section addresses this conflict by directing the
SEC to write rules preventing sales and marketing
considerations from influencing the production of ratings.
Violation of these rules will lead to suspension or revocation
of NRSRO status if the violation affects a rating.
Section 932 addresses the role of the NRSRO compliance
officer, a position created by the Credit Rating Agency Reform
Act of 2006. The section prohibits NRSRO compliance officers
from participating in production of ratings, the development of
ratings methodologies, or the setting of compensation for NRSRO
employees. The section allows the SEC to provide exemptions for
small NRSROs if the SEC finds that compliance would impose an
unreasonable burden.
Section 932 also directs NRSRO compliance officers to
establish procedures for the receipt, retention, and treatment
of complaints about the rating agency or its ratings. Finally,
the section directs the compliance officer to submit to the
NRSRO an annual report on its compliance with the securities
laws, and its related policies and procedures. The NRSRO must
submit this report to the SEC.
Paragraph 6 of Section 932 establishes the Office of Credit
Ratings within the SEC. The Office shall administer the rules
of the SEC with respect to NRSROs to protect investors and the
public interest, to promote accuracy in credit ratings, and to
prevent conflicts of interest from unduly influencing credit
ratings. The Director of the Office will report to the Chairman
of the SEC. The Office will be adequately staffed to fulfill
its statutory role and will include persons with knowledge of
and expertise in corporate, municipal, and structured debt.
The Committee believes that the unique nature of NRSRO
oversight warrants an independent office within the SEC. The
fact that there will be a dedicated Office within the SEC to
focus on NRSROs should improve the quality and efficiency of
the regulation. Many advocated for a separate Office within the
SEC to carry out the regulation of NRSROs because of the
NRSRO's unique and distinct role from the other entities
overseen by the SEC. Mr. Deven Sharma, President of Standard &
Poor's, supports ``creating a dedicated office within the SEC
to oversee NRSROs.''\190\
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\190\Reforming Credit Rating Agencies: Testimony before the U.S.
House Committee on Financial Services, 111th Congress, 1st session,
p.12 (2009) (Testimony of Mr. Deven Sharma).
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The Office of Credit Ratings shall conduct annual
examinations of each NRSRO. Each examination will include a
review of the policies, procedures, and rating methodologies of
the NRSRO and whether the NRSRO follows these; the management
of conflicts of interest by the NRSRO; the implementation of
ethics policies; the internal supervisory controls of the
NRSRO; the governance of the NRSRO; the activities of the NRSRO
compliance officer; the processing of complaints by the NRSRO;
and the policies of the NRSRO governing the post-employment
activities of former staff.
The SEC will make public, in an easily understandable
format, an annual report summarizing the essential findings of
all NRSRO examinations that year. The report shall include the
responses of NRSROs to material regulatory deficiencies
identified by the SEC and to recommendations made by the SEC.
Many interested parties believe that, given the rating
agencies' important role in the financial markets, it is
appropriate and desirable for the SEC to examine them as they
would other securities firms. Mr. Lynn Turner, former Chief
Accountant of the SEC wrote in congressional testimony that
``the SEC has insufficient authority over the credit ratings
agencies despite the roles those firms played in Enron and now
the sub-prime crisis. This deficiency needs to be remedied by
giving the SEC the authority to inspect credit ratings, just as
Congress gave the PCAOB the ability to inspect independent
audits.''\191\ Ms. Barbara Roper, Director of Investor
Protection at the Consumer Federation of America, wrote in
testimony that ``the agency should have authority to examine
individual ratings engagements to determine not only that
analysts are following company practices and procedures but
that those practices and procedures are adequate to develop an
accurate rating. Congress would need to ensure that any such
oversight function was adequately funded and staffed.''\192\
Standard & Poor's President Deven Sharma wrote in testimony
that S&P supports ``empowering the SEC to conduct frequent
reviews of NRSROs to ensure that NRSROs follow their internal
controls and policies for determining ratings and managing
conflicts of interest.''\193\
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\191\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p. 11 (2009)
(Testimony of Mr. Lynn Turner).
\192\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.9
(2009) (Testimony of Ms. Barbara Roper).
\193\Reforming Credit Rating Agencies: Testimony before the U.S.
House Committee on Financial Services, 111th Congress, 1st session,
p.12 (2009) (Testimony of Mr. Deven Sharma).
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Accountability
Paragraph (2) of Section 932 provides that the SEC may
temporarily suspend or permanently revoke the registration of
an NRSRO with respect to a particular class or subclass of
securities, if the SEC finds, on the record after notice and
opportunity for hearing, that NRSRO does not have adequate
financial and managerial resources to consistently produce
credit ratings with integrity. In determining whether an NRSRO
lacks such resources, the SEC shall consider an NRSRO's failure
to consistently produce accurate ratings over a sustained
period of time.
Subsection (q) of Paragraph 6 of Section 932 directs the
SEC to require that each NRSRO publicly disclose information on
the initial credit ratings published by the NRSRO for each type
of obligor, security, and money market instrument and any
subsequent changes to such credit ratings. The purpose of this
disclosure is to allow users of credit ratings to compare the
performance and accuracy of ratings issued by different NRSROs.
Disclosures would be clear and informative for investors with
varying levels of financial sophistication.
This provision seeks to address the lack of market
competition in the credit rating industry by allowing investors
to compare NRSRO performance. Industry analysts often identify
the lack of competition as one reason why the industry
performed poorly in rating securities, such as mortgage-backed
securities, and thus contributed to the economic crisis of
2008. To portray the concentrated market for credit ratings,
Sean Egan, Managing Director of Egan-Jones Ratings Co., noted
that S&P and Moody's control over 90% of the revenues in the
ratings industry.\194\ This provision will make rating
performance public--the goal is to foster market competition by
forcing ratings firms to compete on the basis of their rating
accuracy. In support of this proposal, Mr. George Miller,
Executive Director of the American Securitization Forum, wrote
in congressional testimony ``we support the publication in a
format reasonably accessible to investors of a record of all
ratings actions for securitization instruments for which
ratings are published. We believe that publication of these
data will enable investors and other market participants to
evaluate and compare the performance, stability and quality of
ratings judgments over time.''\195\ Ms. Rita Bolger, on behalf
of Standard & Poor's, an NRSRO, supports this performance
disclosure. She wrote in congressional testimony that a way to
promote sound rating oversight would be to ``require registered
rating agencies to publicly issue performance measurement
statistics over the short, medium, and long term, and across
asset classes and geographies.''\196\
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\194\Examining the Role of Credit Rating Agencies in the Capital
Markets: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 109th Congress, 2nd session, p.1 (2005)
(Testimony of Mr. Sean Egan).
\195\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.25 (2009) (Testimony of Mr.
George Miller).
\196\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.9
(2009) (Testimony of Ms. Rita Bolger).
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Finally, this subsection makes accommodation for
subscriber-pay NRSROs, by mandating that the disclosure be
appropriate to the business model of an NRSRO. For these
NRSROs, the publication of rating performance would likely be
unsustainable because they rely on credit rating users to pay
them for ratings.
During the markup of this legislation, the Committee
adopted an amendment proposed by Senator Bennet that would
require that at least one-half the members of NRSRO boards be
independent directors. Independent directors are defined as
those who do not accept consulting, advisory, or other fees
from the NRSRO; are not associated with the NRSRO or an
affiliate; and do not participate in any deliberation involving
a rating in which the independent director has a financial
interest. The NRSRO board must be responsible for establishing,
maintaining, and enforcing policies and procedures for
determining credit ratings; preventing conflicts of interests;
the internal control systems; and compensation practices. The
provision authorizes the SEC to grant an exemption from
independence rules for small NRSROs where compliance would
present an unreasonable burden, provided that the
responsibilities of the board are delegated to a committee
including at least one user of NRSRO ratings.
Disclosure
Subsection (r) of Paragraph 6 of Section 932 directs the
SEC to prescribe rules to require each NRSRO to ensure that
credit ratings are determined using procedures and
methodologies that are approved by the board of directors or
senior credit officer. The SEC's rules must require that
material changes to ratings procedures and methodologies be
applied consistently and publicly disclosed. Such changes must
be applied to all credit ratings to which they apply within a
reasonable time period, to be determined by the SEC.
The rules will also require each NRSRO to notify users of
credit ratings when a material change is made to a procedure or
methodology, and when a significant error is identified in a
procedure or methodology that may result in credit rating
actions. Ms. Rita Bolger, Senior Vice President and Associate
General Counsel of Standard & Poor's, wrote in testimony for
the Senate Banking Committee that ``with greater transparency
of credit rating agency methodologies, investors would be in a
better position to assess the opinions.''\197\
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\197\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.9
(2009) (Testimony of Ms. Rita Bolger).
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Subsection (s) of Paragraph 6 of Section 932 directs the
SEC to require NRSROs, by rule, to publish a form with each
rating that discloses qualitative and quantitative information
that is intended to enable investors and users of credit
ratings to better understand the main principles and
assumptions that underlie the rating. The disclosures shall be
easy to use, directly comparable across different classes of
securities, and may be provided in either paper or electronic
form, as the SEC may, by rule, determine.
The qualitative content of the form shall include the
credit ratings produced; the main assumptions and principles
used in constructing procedures and methodologies (including
qualitative methodologies and quantitative inputs and
assumptions about the correlation of defaults across obligors
used in rating structured products); the potential limitations
of the credit ratings and the types of risks excluded from the
credit ratings that the NRSRO does not comment on; information
on the uncertainty of the credit rating including information
on the reliability, accuracy, and quality of the data relied on
in determining the credit rating; a statement on the
reliability and limitations of the data relied upon and any
other data accessibility limitations; and whether and to what
extent third party due diligence services have been used by the
NRSRO, including a description of the information that such
third party reviewed in conducting due diligence services and a
description of the findings or conclusions of such third party.
The form shall include an overall assessment of the quality
of information available and considered in producing a rating
in relation to the quality of information available to the
NRSRO in rating similar issuances; information relating to
conflicts of interest of the nationally recognized statistical
rating organization; and such additional information as the SEC
may require.
The quantitative content will include an explanation or
measure of the potential volatility of the credit rating
(including any factors that might lead to a change in the
credit ratings), information on the sensitivity of the rating
to assumptions made by the NRSRO, and the extent of the change
that a user can expect under different market conditions. In
addition, the disclosures will include information on the
historical performance of the rating and the expected
probability of default and the expected loss in the event of
default.
These substantial disclosures will give investors and other
market participants far more information about the credit risk
of a debt issue and the reliability of ratings. Dr. William
Irving, Portfolio Manager at Fidelity Investments, wrote in
congressional testimony that the Committee should ``facilitate
greater transparency of the methodology and assumptions used by
the rating agencies to determine credit ratings. In particular,
there should be public disclosure of the main assumptions
behind rating methodologies and models. Furthermore, when those
models change or errors are discovered, the market should be
notified.''\198\ Mr. George Miller, Executive Director of the
American Securitization Forum, added that he ``strongly
supports enhanced disclosure of securitization ratings methods
and processes, including information relating to the use of
ratings models and key assumptions utilized by those
models.''\199\ The Council of Institutional Investors wrote in
a letter to Senator Dodd that it supports these reforms
designed to ``improve the transparency of rating methodologies
and assumptions and make rating agencies truly accountable to
the investors that depend on them.''\200\
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\198\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.12 (2009) (Testimony of Dr.
William Irving).
\199\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.25 (2009) (Testimony of Mr.
George Miller).
\200\Mr. Jeff Mahoney, Council of Institutional Investors, letter
to Senator Dodd, p. 3, November 18, 2009.
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Another disclosure that the NRSROs will have to make
regards due diligence services. Subsection (s) provides the
findings and conclusions of any third-party due diligence
report obtained by the issuer or underwriter of an asset-backed
security shall be made public, in a format to be determined by
the SEC. The disclosures shall be in a manner that allows the
public to determine the adequacy and level of due diligence
services provided by a third party. Many analysts point to the
decline of due diligence as a factor that contributed to the
poor performance of asset-backed securities during the crisis.
Professor John Coffee described the effect of poor due
diligence in the credit rating industry in testimony for the
Senate Banking Committee: ``Unlike other gatekeepers, the
credit rating agencies do not perform due diligence or make its
performance a precondition of their ratings. In contrast,
accountants are, quite literally, bean counters who do conduct
audits. But the credit rating agencies do not make any
significant effort to verify the facts on which their models
rely (as they freely conceded to this Committee in earlier
testimony here). Rather, they simply accept the representations
and data provided them by issuers, loan originators and
underwriters. The problem this presents is obvious and
fundamental: no model, however well designed, can outperform
its information inputs--Garbage, In; Garbage Out. . . .
Ultimately, unless the users of credit ratings believe that
ratings are based on the real facts and not just a hypothetical
set of facts, the credibility of ratings, particularly in the
field of structured finance, will remain tarnished, and private
housing finance in the U.S. will remain starved and underfunded
because it will be denied access to the broader capital
markets.''\201\ Ms. Barbara Roper, Director of Investor
Protection at the Consumer Federation of America, also believes
that this provision is important. She wrote in congressional
testimony that new legislation should address ``lack of due
diligence regarding information on which ratings are
based.''\202\
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\201\Examining Proposals to Enhance the Regulation of Credit Rating
Agencies: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, pp.1-2 (2009)
(Testimony of Professor John Coffee).
\202\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.8
(2009) (Testimony of Ms. Barbara Roper).
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Section 933. State of mind in private actions
Section 933 was introduced by Senator Reed. It provides
that the enforcement and penalty provisions applicable to
statements made by a credit rating agency shall apply in the
same manner and to the same extent as to statements made by a
registered public accounting firm or a securities analyst, and
such statements shall not be deemed forward looking statements.
In actions for money damages brought against a credit rating
agency or a controlling person, it shall be sufficient for
pleading any required state of mind in relation to such action,
that the complaint state facts giving rise to a strong
inference that the credit rating agency knowingly or recklessly
failed to conduct a reasonable investigation of the factual
elements of the rated security, or failed to obtain reasonable
verification of such factual elements from independent sources
that it considered to be competent.
Section 933 specifies that, for purposes of passing the
pleading test of the Private Securities Litigation Reform Act,
plaintiffs need not plead that the CRA ``knowingly or
recklessly'' engaged in a deceptive misrepresentation or
omission in communicating with investors, but instead requires
only that they plead that the CRA ``knowingly or recklessly
failed . . . to conduct a reasonable investigation . . . with
respect to . . . factual elements . . . or to obtain reasonable
verification of such . . . elements . . .''
The Section permits plaintiffs to more easily pass the
motion to dismiss stage of litigation. It does not change the
ultimate standard used by a fact-finder in determining whether
the basic elements of 10b-5 have been met.
Columbia University Law Professor John C. Coffee testified
before the Committee that this provision ``struck a very
sensible compromise in my judgment. It created a standard of
liability for the rating agencies, but one with which they
easily could comply (if they tried).'' He opined that this
``language does not truly expose rating agencies to any serious
risk of liability--at least if they either conduct a reasonable
investigation themselves or obtain verification from others
(such as a due diligence firm) that they reasonably believed to
be competent and independent . . . so that a rating agency
would be fully protected when it received such a certification
from an independent due diligence firm that covered the basic
factual elements in its model.''
Professor Coffee further testified, ``The case for this
limited litigation threat is that it is unsafe and unsound to
let rating agencies remain willfully ignorant. Over the last
decade, they have essentially been issuing hypothetical ratings
in structured finance transactions based on hypothetical
assumed facts provided them by issuers and underwriters. Such
conduct is inherently reckless; the damage that it caused is
self-evident, and the proposed language would end this state of
affairs (without creating anything approaching liability for
negligence).''\203\
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\203\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Professor John Coffee).
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Section 934. Referring tips to law enforcement or regulatory
authorities
Section 934 provides that each NRSRO will refer to the
appropriate law enforcement or regulatory authorities any
information that the NRSRO receives and finds credible that
alleges that an issuer of securities rated by the NRSRO has
committed or is committing a violation of law that has not been
adjudicated by a Federal or State court. This is in effect a
mandatory whistle-blowing provision, and exceptions could be
created to cover circumstances when the compliance officer
concluded that the information was false or unreliable. This
provision requires the NRSRO to determine whether it feels the
information is credible, but does not require the NRSRO to
undertake extensive fact finding or analysis or to determine
whether a violation of law has occurred.
Section 935. Consideration of information from sources other than the
issuer in rating decisions
Section 935 provides that NRSROs must consider information
about an issuer that the NRSRO has, or receives from a source
other than the issuer, that the NRSRO finds credible and
potentially significant to a rating decision. The Section does
not require an NRSRO to initiate a search for such information.
The information is expected to be evaluated on its own merits
as to whether it indeed should affect the rating. The Committee
believes that if the NRSRO possesses credible information that
is significant to a rating decision about an issuer, it should
consider it even if it has not undertaken to independently
verify information it has received from an issuer.
NRSROs use data received from issuers in formulating a
rating and may not undertake to verify it. For example, one
NRSRO states:
While [the NRSRO] has obtained information from
sources it believes to be reliable, [the NRSRO] does
not perform an audit and undertakes no duty of due
diligence or independent verification of any
information it receives.
This type of disclosure and policy may create the
appearance that the NRSRO could receive credible,
material information about the creditworthiness of an
issuer from an outside source but choose not to
consider it in formulating a rating. Such information
could come from a highly credible press report,
information from a knowledgeable industry insider,
views from a former employee or other source.
Mr. James Gellert, Chairman of Rapid Ratings
International, Inc., wrote in congressional testimony
that ``we believe that, if a rating agency's business
model is to provide qualitative assessments of an
entity or pool of assets collateralizing a structured
product, it should take into account all data it can
reasonably attain and qualify as being reliable.''\204\
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\204\Examining Proposals to Enhance the Regulation of Credit Rating
Agencies: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p.18 (2009)
(Testimony of Mr. James Gellert).
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Section 936. Qualification standards for credit rating analysts
Section 936 directs the SEC to issue rules reasonably
designed to ensure that any person employed by an NRSRO to
perform credit ratings meets standards of training, experience,
and competence necessary to produce accurate ratings; and is
tested for knowledge of the credit rating process.
Following the devastating impact on investors, the economy,
and families that erroneous ratings had during the credit
crisis, the Committee feels there is need to improve the
analysis underlying credit ratings. This requirement is
intended to improve the quality of ratings by increasing the
skills of those who formulate them. This section would require
credit rating analysts to meet high professional standards for
their industry, just as investment advisers, registered
representatives, and auditors do for theirs.
Mr. Mark Froeba testified before the Committee about
concerns that ``Every rating agency employs `rating analysts'
but there are no independent standards governing this
`profession': there are no minimum educational requirements,
there is no common code of ethical conduct, and there is no
continuing education obligation. Even where each agency has its
own standards for these things, the standards differ widely
from agency to agency. One agency may assign a senior analyst
with a PhD in statistics to rate a complex transaction; another
might assign a junior analyst with a BA in international
relations to the same transaction. The staffing decision might
appear to investors as yet another tool to manipulate the
rating outcome.''\205\
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\205\Examining Proposals to Enhance the Regulation of Credit Rating
Agencies: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Mark Froeba).
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Section 937. Timing of regulations
Section 937 directs the SEC to issue final regulations
within 1 year of the date of enactment of the Act.
Section 938. Universal ratings symbols
Section 938 was introduced by Senator Menendez. It requires
NRSROs to clearly define any symbols used to denote a credit
rating, and apply any such symbols in a consistent manner to
all types of securities and money market instruments to which
they are applied. The Committee believes that an NRSRO's credit
rating symbol should have the same meaning about
creditworthiness when it is applied to any issuer--the same
symbol should not have different meaning depending on the
issuer. This Section does not dictate the meaning of any credit
rating--whether it refers to an issuer's likelihood of default,
ability to pay on time, or other factors. Also, this Section
does not prevent an NRSRO from using distinct sets of symbols
to denote credit ratings for different types of securities.
Some observers have expressed concerns that some rating
agencies apply stricter standards to municipal debt than to
corporate debt. Consumer Federation of America and Americans
for Financial Reform stated, ``Most municipal bonds are rated
on a different, more conservative rating scale than corporate
bonds. This dual system employed by the largest rating agencies
ends up costing state and local governments and their taxpayers
over a billion dollars a year, a cost these governments can ill
afford. Bond issuers, be they corporate bond issuers or
municipal bond issuers, should be rated on the same standard--
the likelihood of default.''\206\ They recommended that the
legislation require each NRSRO to: (1) establish, maintain and
enforce written policies and procedures designed to assess the
risk that investors in securities and money market instruments
may not receive payment in accordance with the terms of such
securities and instruments, (2) define clearly any credit
rating symbols used by the organization, and (3) apply such
credit rating symbols in a consistent manner for all types of
securities and money market instruments.''\207\ The National
Association of State Treasurers stated that ``Bond ratings have
a direct impact on the interest rates at which governments can
issue their bonds to finance the construction of critically-
need infrastructure, and the ratings given to these bonds by
the major credit ratings agencies play a large role in
determining the cost that taxpayers assume when their
governments invest in infrastructure . . . We believe that
ratings applied to municipal bonds should indicate the same
risk as the identical rating applied to a corporate bond, while
also recognizing the need for relative ratings among municipal
issuers. We further believe that ratings should measure the
ability of an issuer to meet its obligation to investors as
promised in the bond documents, such obligation primarily being
to pay its debt service on time and in full.''\208\
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\206\Consumer Federation of America, Letter to Senators Dodd and
Shelby, November 24, 2009.
\207\Letter to Chairman Dodd and Ranking Member Shelby, November
24, 2009.
\208\Letter dated November 17, 2009.
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Section 939. Government Accountability Office study and federal agency
review of required uses of nationally recognized statistical
rating organization ratings
Section 939 directs the GAO to study the scope of Federal
and State laws and regulations with respect to the regulation
of securities markets, banking, insurance, and other areas that
require the use of ratings issued by NRSROs. Consulting with a
range of regulators and market participants, GAO shall evaluate
the necessity of such rating requirements and the potential
impact on markets and investors of removing them. Within 2
years of the date of enactment of this Act, the GAO shall
report to Congress with recommendations on which ratings
requirements, if any, could be removed with minimal disruption
to the markets and whether the financial markets and investors
would benefit from the rescission of the ratings requirements
identified by the study.
Within one year of the completion of GAO's report, the SEC
and other financial regulators shall review rating requirements
in their regulations, and shall remove such rating
requirements, unless they determine that there is no reasonable
alternative standard of creditworthiness to replace a credit
rating, and that removing the rating requirement would be
inconsistent with the purposes of the statute that authorized
the regulation and not in the public interest.
Currently, there are numerous instances in government rules
and regulations that require the use of NRSRO ratings. This
gives the ratings a tacit government sanction. Many observers
have recommended to the Senate Banking Committee to enact
policy to remove these references to ratings. Professor
Lawrence White advised ``Eliminate regulatory reliance on
ratings--eliminate the force of law that has been accorded to
these third-party judgments. The institutional participants in
the bond markets could then more readily (with appropriate
oversight by financial regulators) make use of a wider set of
providers of information, and the bond information market would
be opened to new ideas and new entry in a way that has not been
possible for over 70 years.''
One concern is that the reliance on ratings has become so
prevalent that the abrupt removal of ratings could cause
unintended consequences and negative effects in the market.
Therefore, the Committee provides for a GAO study of the
reliance on ratings. Supporting the caution behind this
approach, Mr. George Miller, Executive Director of the American
Securitization Forum, wrote in congressional testimony ``ASF
believes that credit ratings are an important part of existing
regulatory regimes, and that steps aimed at reducing or
eliminating the use of ratings in regulation should be
considered carefully, to avoid undue disruption to market
function and efficiency.'' The Investor's Working Group\209\
and Mr. Andrew Davidson\210\ also support the ultimate goal of
reducing the reliance on ratings. The studies would identify
those requirements for NRSRO ratings for which there is a
necessity and those requirements which could be removed with
minimal disruption to the markets over a sufficiently long time
period to fully explore possible unintended consequences,
alternative measures of creditworthiness and other factors
which can ultimately lead to strengthening the financial
markets.
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\209\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, July 2009.
\210\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session (2009) (Testimony of Mr. Andrew
Davidson).
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Section 939A. Securities and Exchange Commission study on strengthening
credit rating agency independence
Section 939A directs the SEC to conduct a study of the
independence of NRSROs, evaluate the management of conflicts of
interest by NRSROs, and evaluate the potential impact of rules
prohibiting an NRSRO that provided a rating to an issuer from
providing other services to the issuer. The Committee intends
this study to include an identification of the types and scope
of services provided by NRSROs and which of these services
raises a potential for raising a conflict that could change a
rating and to cover other relevant issues identified by GAO.
Section 939B. Government Accountability Office study on alternative
business models
Section 939B directs the GAO to conduct a study on
alternative means of compensating NRSROs in order to create
incentives for NRSROs to provide more accurate ratings and any
statutory changes that would be required to facilitate these
changes. The GAO will submit this report, with recommendations,
within one year of passage of the Act. The predominant NRSRO
business model involves the issuer paying for the rating, while
a small number of NRSROs rely on subscription fees from users.
The Committee asks the GAO to analyze which model is likely to
produce the most accurate ratings.
The Committee recognizes that conflicts of interest exist
for NRSROs and is interested in an analysis of how and whether
they are effectively managed so that they do not unfairly
influence ratings decisions. The study should include any
recommendations for legislative, regulatory or voluntary
industry action. Mr. Stephen Joynt, President and CEO of Fitch,
testified ``The majority of Fitch's revenues are fees paid by
issuers for assigning and maintaining ratings. This is
supplemented by fees paid by a variety of market participants
for research subscriptions. The primary benefit of this model
is that it enables Fitch to be in a position to offer
analytical coverage on every asset class in every capital
market--and to make our rating opinions freely available to the
market in real-time, thus enabling the market to freely and
fully assess the quality of our work. Fitch has long
acknowledged the potential conflicts of being an issuer-paid
rating agency. Fitch believes that the potential conflicts of
interest in the ``issuer pays'' model have been, and continue
to be, effectively managed through a broad range of policies,
procedures and organizational structures aimed at reinforcing
the objectivity, integrity and independence of its credit
ratings, combined with enhanced and ongoing regulatory
oversight.''
Mark Froeba, Principal at PF2 Securities Evaluations, Inc.
and former Senior Vice President at Moody's, testified that
``there are those who believe that real rating agency reform
requires a return to an investor-pay model. But there may be a
third way, a business model that preserves the issuer-pay
``delivery system'' (the issuer still gets the bill for the
rating) but incorporates the incentives of the investor-pay
model. . . . These and other reforms are necessary not only to
restore investor confidence in ratings but also to prevent
future ratings-related financial crises.''\211\
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\211\Examining Proposals to Enhance the Regulation of Credit Rating
Agencies: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p.18 (2009)
(Testimony of Mr. Mark Froeba).
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Section 939C. Government Accountability Office study on the creation of
an independent professional analysts organization
Section 939C directs the GAO to conduct a study on the
feasibility and merits of creating an independent professional
organization for NRSRO rating analysts that would establish
independent standards for governing the rating analyst
profession, establishing a code of ethical conduct, and
overseeing the rating analyst profession. The GAO shall submit
a report to the relevant congressional committees within one
year of passage of the Act. In the aftermath of the devastating
financial crisis caused in part by poor credit ratings, the
Committee is interested in exploring means to increase the
skills of the professionals who produce credit ratings. This
Section directs the GAO to explore the potential impact of an
independent professional analysts organization. Mark Froeba,
Principal at PF2 Securities Evaluations, Inc. and former Senior
Vice President at Moody's, testified that he recommended the
creation of ``an independent professional organization for
rating analysts. Every rating agency employs `rating analysts'
but there are no independent standards governing this
`profession': there are no minimum educational requirements,
there is no common code of ethical conduct, and there is no
continuing education obligation. Even where each agency has its
own standards for these things, the standards differ widely
from agency to agency. One agency may assign a senior analyst
with a PhD in statistics to rate a complex transaction; another
might assign a junior analyst with a BA in international
relations to the same transaction . . . Creating one
independent professional organization to which rating analysts
from all rating agencies must belong will ensure uniform
standards especially ethical standards--across all the rating
agencies. It would also provide a forum external to the
agencies where rating analysts might bring confidential
complaints about ethical concerns. An independent organization
could track and report the nature and number of these
complaints and alert regulators if there are patterns in the
complaints, problems at particular agencies, and even whether
there are problems with particular managers at one rating
agency. Finally, such an organization should have the power to
discipline analysts for unethical behavior.''\212\
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\212\Examining Proposals to Enhance the Regulation of Credit Rating
Agencies: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p.18 (2009)
(Testimony of Mr. Mark Froeba).
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Subtitle D
Section 941. Regulation of credit risk retention
This section requires securitizers, defined as those who
issue, organize, or initiate asset-backed securities, to retain
an economic interest in a material portion of the credit risk
for any asset that securitizers transfer, sell, or convey to a
third party. The provision intends to create incentives that
will prevent a recurrence of the excesses and abuses that
preceded the crisis, restore investor confidence in asset-
backed finance, and permit securitization markets to resume
their important role as sources of credit for households and
businesses.
The Committee's investigation into the causes of the
financial crisis identified abuses of the securitization
process as a major contributing factor. Two problems emerged in
the crisis. First, under the ``originate to distribute'' model,
loans were made expressly to be sold into securitization pools,
which meant that the lenders did not expect to bear the credit
risk of borrower default. This led to significant deterioration
in credit and loan underwriting standards, particularly in
residential mortgages. According to the testimony of Dr.
William Irving, Portfolio Manager of Fidelity Investments:
Without a doubt, securitization played a role in this
crisis. Most importantly, the ``originate-to-
distribute'' model of credit provision seemed to spiral
out of control. Under this model, intermediaries found
a way to lend money profitably without worrying if the
loans were paid back. The loan originator, the
warehouse facilitator, the security designer, the
credit rater, and the marketing and product-placement
professionals all received a fee for their part in
helping to create and distribute the securities. These
fees were generally linked to the size of the
transaction and most of them were paid up front. So
long as there were willing buyers, this situation
created enormous incentive to originate mortgage loans
solely for the purpose of realizing that up-front
intermediation profit.\213\
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\213\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, (2009) (Testimony of Dr. William
Irving).
Second, it proved impossible for investors in asset-backed
securities to assess the risks of the underlying assets,
particularly when those assets were resecuritized into complex
instruments like collateralized debt obligations (CDOs) and
CDO-squared. With the onset of the crisis, there was widespread
uncertainty regarding the true financial condition of holders
of asset-backed securities, freezing interbank lending and
constricting the general flow of credit. Complexity and opacity
in securitization markets created the conditions that allowed
the financial shock from the subprime mortgage sector to spread
into a global financial crisis, as Professor Patricia A. McCoy
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testified before the Committee:
General investor panic is [another] reason for
contagion. Even in transactions involving no nonprime
collateral, concerns about the nonprime crisis had a
ripple effect, making it hard for companies and cities
across-the-board to secure financing. Banks did not
want to lend to other banks out of fear that
undisclosed nonprime losses might be lurking on their
books. Investors did not want to buy other types of
securitized bonds, such as those backed by student
loans or car loans, because they lost faith in ratings
and could not assess the quality of the underlying
collateral.\214\
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\214\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, (2009) (Testimony of Patricia A.
McCoy).
Section 941 directs the Federal banking agencies and the
SEC to jointly prescribe regulations to require any securitizer
to retain a material portion of the credit risk of any asset
that the securitizer, through the issuance of an asset-backed
security, transfers, sells, or conveys to a third party. When
securitizers retain a material amount of risk, they have ``skin
in the game,'' aligning their economic interests with those of
investors in asset-backed securities. Securitizers who retain
risk have a strong incentive to monitor the quality of the
assets they purchase from originators, package into securities,
and sell.
The regulations will prohibit securitizers from hedging or
otherwise transferring the credit risk they are required to
retain. The prohibition does not extend to hedging risks other
than credit risk (such as interest rate risk) associated with
the retained assets or position. Originators (defined as
persons who through the extension of credit or otherwise create
financial assets that collateralize an asset-backed security,
and sell assets to a securitizer) will come under increasing
market discipline because securitizers who retain risk will be
unwilling to purchase poor-quality assets. Thus, the bill does
not require that the regulations impose risk retention
obligations on originators. Risk retention may be divided
between securitizers and originators only if the regulators
consider that assets being securitized do not have
characteristics of low credit risk, that conditions in
securitization markets are creating incentives for imprudent
origination, and that allocating part of the risk retention
obligation to originators would not prevent consumers and
businesses from obtaining credit on reasonable terms.
There is broad support for risk retention by securitizers.
The provision was included in the Treasury Department's 2009
legislative proposal.\215\ Mr. George Miller, Executive
Director of the American Securitization Forum, testified before
the Committee that ``we support the concept of requiring
retention of a meaningful economic interest in securitized
loans as a means of creating a better alignment of incentives
among transaction participants.''\216\ The Group of Thirty
recommended risk retention as part of broad financial reform:
\215\Title IX--Additional Improvements to Financial Markets
Regulation Subtitle D, U.S. Department of the Treasury, 2009,
www.financialstability.gov.
\216\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.19 (2009) (Testimony of Mr.
George Miller).
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The healthy redevelopment of securitized credit
markets requires a restoration of market confidence in
the adequacy and sustainability of credit underwriting
standards. To help achieve this, regulators should
require regulated financial institutions to retain a
meaningful portion of the credit risk they are
packaging into securitized and other structured credit
products.\217\
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\217\Financial Reform: A Framework for Financial Stability, Group
of Thirty, p. 49, January 15, 2009.
The Consumer Federation of America\218\, CalPERS\219\, and the
Investor's Working Group\220\ also support this provision.
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\218\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Ms. Barbara Roper).
\219\Regulating Hedge Funds and Other Private Investment Pools:
Testimony before the Subcommittee on Securities, Insurance, and
Investment of the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, (2009) (Testimony of Mr. Joseph
Dear).
\220\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, July 2009.
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The Committee believes that implementation of risk
retention obligations should recognize the differences in
securitization practices for various asset classes. Witnesses
before the Committee and a number of market participants have
indicated that a ``one size fits all'' approach to risk
retention may adversely affect certain securitization markets.
For example, Mr. J. Christopher Hoeffel of the Commercial
Mortgage Securities Association testified that ``[P]olicymakers
must ensure that any regulatory reforms are tailored to address
the specific needs of each securitization asset class. Again,
CMSA does not oppose these [risk retention] measures per se,
but emphasizes that they should be tailored to reflect key
differences between the different asset-backed securities
markets.''\221\ Accordingly, the bill requires that the initial
joint rulemaking include separate components addressing
individual asset classes--home mortgages, commercial mortgages,
commercial loans, auto loans, and any other asset class that
the regulators deem appropriate. The Committee expects that
these regulations will recognize differences in the assets
securitized, in existing risk management practices, and in the
structure of asset-backed securities, and that regulators will
make appropriate adjustments to the amount of risk retention
required.
---------------------------------------------------------------------------
\221\[Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, (2009) (Testimony of Mr. J.
Christopher Hoeffel).]
---------------------------------------------------------------------------
In addition, the risk retention rules may provide a total
or partial exemption for any securitization, as may be
appropriate in the public interest and for the protection of
investors. The Committee expects that asset-backed securities
backed by the full faith and credit of the United States, or
where the underlying assets were guaranteed by an agency of the
United States, would qualify for such an exemption.
The section provides a baseline risk retention amount of 5
percent of the credit risk in any securitized asset. The figure
may be set higher at the regulators' discretion, or it may be
reduced below 5 percent when the assets securitized meet
standards of low credit risk to be established by rule for the
various asset classes. The Committee believes that regulators
should have flexibility in setting risk retention levels, to
encourage recovery of securitization markets and to accommodate
future market developments and innovations, but that in all
cases the amount of risk retained should be material, in order
to create meaningful incentives for sound and sustainable
securitization practices.
The section also authorizes regulators to make exemptions,
exceptions, or adjustments to the risk retention rules,
provided that any such exemptions, exceptions, or adjustments
help ensure high underwriting standards, encourage appropriate
risk management practices, improve access to credit on
reasonable terms, or are otherwise in the public interest.
Section 942. Disclosures and reporting for asset-backed securities
Section 942 seeks to improve transparency in asset-backed
securities. It directs the SEC to adopt regulations requiring
each issuer of an asset-backed security to disclose, for each
tranche or class of security, information regarding the assets
backing that security. These disclosures shall be in a format
that facilitates comparison of such data across securities in
similar types of asset classes. Issuers of asset-backed
securities shall disclose asset-level or loan-level data
necessary for investors to independently perform due diligence.
This data would include data having unique identifiers relating
to loan brokers or originators, the nature and extent of the
compensation of the broker or originator of the assets backing
the security, and the amount of risk retention by the
originator or the securitizer of such assets. The Committee
does not expect that disclosure of data about individual
borrowers would be required in cases such as securitizations of
credit card or automobile loans or leases, where asset pools
typically include many thousands of credit agreements, where
individual loan data would not be useful to investors, and
where disclosure might raise privacy concerns.
Mr. George Miller, Executive Director of the American
Securitization Forum, wrote in testimony for the Committee that
``ASF supports increased transparency and standardization in
the securitization markets, and related improvements to the
securitization market infrastructure. . . . ASF believes that
every mortgage loan should be assigned a unique identification
number at origination, which would facilitate the
identification and tracking of individual loans as they are
sold or financed in the secondary market, including via RMBS
securitization.''\222\ The Investor's Working Group wrote in a
report that ``the SEC should develop a regulatory regime for
such asset-backed securities that would require issuers to make
prospectuses available for potential investors in advance of
their purchasing decisions. These prospectuses should disclose
important information about the securities, including the terms
of the offering, information about the sponsor, the issuer and
the trust, and details about the collateral supporting the
securities. Such new rules would give investors critical
information they need to perform due diligence on offerings
prior to investing. It would also create better opportunities
for due diligence by the underwriters of such securities, thus
adding additional levels of oversight of the quality and
appropriateness of structured offerings.''\223\ Professor
Patricia McCoy wrote in testimony ``the SEC should require
securitizers to provide investors with all of the loan-level
data they need to assess the risks involved. . . . In addition,
the SEC should require securitizers and servicers to provide
loan-level information on a monthly basis on the performance of
each loan and the incidence of loan modifications and
recourse.''\224\ CalPERS\225\, Mr. Andrew Davidson\226\, and
Dr. William Irving\227\ also supported enhanced disclosure in
testimony before the Committee.
---------------------------------------------------------------------------
\222\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.18 (2009) (Testimony of Mr.
George Miller).
\223\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, p.14, July 2009.
\224\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p.13 (2009) (Testimony of
Professor Patricia McCoy).
\225\Regulating Hedge Funds and Other Private Investment Pools:
Testimony before the Subcommittee on Securities, Insurance, and
Investment of the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session (2009) (Testimony of Mr. Joseph
Dear).
\226\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session (2009) (Testimony of Mr. Andrew
Davidson).
\227\Securitization of Assets: Problems and Solutions: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs, 111th Congress, 1st session, p. (2009) (Testimony of Dr.
William Irving).
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Section 943. Representations and warranties in asset-backed offerings
This section directs the SEC to prescribe regulations on
the use of representations and warranties in the market for
asset-backed securities that require each NRSRO to include in
any report accompanying a credit rating a description of the
representations, warranties, and enforcement mechanisms
available to investors and how they differ from the
representations, warranties, and enforcement mechanisms in
issuances of similar securities. The SEC will also prescribe
rules to require any originator to disclose fulfilled
repurchase requests across all trusts aggregated by the
originator, so that investors may identify asset originators
with clear underwriting deficiencies.
This provision was included in the Treasury Department's
legislative proposal.\228\ Moody's Investor Services described
the use of representations and warranties and pointed out
weaknesses in their current usage:
---------------------------------------------------------------------------
\228\Title IX--Additional Improvements to Financial Markets
Regulation Subtitle D, U.S. Department of the Treasury, 2009,
www.financialstability.gov.
[T]he seller or originator in structured securities
makes representations and warranties regarding the
characteristics of the loans they sell into
securitizations. In light of recent events, typical
representations and warranties should be strengthened.
In addition to other matters, the seller could provide
representations and warranties to investors as to the
quality and accuracy of all information presented to
investors, rating agencies and other market
participants. The value of representations and
warranties is diminished when made by entities that are
not financially strong, as such entities may be less
able to fulfill their obligation to repurchase loans
that breach the representations and warranties.\229\
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\229\Moody's Proposes Enhancements to Non-Prime RMBS
Securitization, Moody's, Special Report, p.2, September 25, 2007.
The Committee believes that enhanced disclosure will allow
investors to better evaluate representations and warranties and
create incentives for issuers to insist that originators back
up their representations and warranties with real financial
resources.
Section 944. Exempted transactions under the Securities Act of 1933
Section 944 removes the Securities Act of 1933 exemption of
transactions involving offers or sales of one or more
promissory notes directly secured by a first lien on a single
parcel of real estate upon which is located a dwelling or other
residential or commercial structure.
Section 945. Due diligence analysis and disclosure in asset-backed
securities issues
Section 945 directs the SEC to issue rules that require any
issuer of an asset-backed security to perform a due diligence
analysis of the assets underlying the asset-backed security;
and to disclose the nature of this analysis. Professor John
Coffee, in congressional testimony, called for action to ``re-
introduce due diligence into the securities offering
process.''\230\
---------------------------------------------------------------------------
\230\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p.53 (2009)
(Testimony of Professor John Coffee).
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Subtitle E
Section 951. Shareholder vote on executive compensation disclosures
Section 951 provides that any proxy or consent or
authorization for an annual or other meeting of the
shareholders will include a separate resolution subject to
shareholder advisory vote to approve the compensation of
executives. The Committee believes that shareholders, as the
owners of the corporation, have a right to express their
opinion collectively on the appropriateness of executive pay.
The vote must be tabulated and reported, but the result is not
binding on the board or management.
In crafting this Section, there was consideration of
alternative time intervals, such as votes every three years,
and of whether votes after the first year should be triggered
only by a failure to receive a minimum percentage of votes in
support of the compensation plan. This provision would not
preclude an issuer from seeking more specific shareholder
opinion through separate votes on cash compensation, golden
parachute policy, severance or other aspects of compensation.
A ``say on pay'' proposal was included in the Treasury
Department's legislative proposal. The economic crisis revealed
instances in which corporate executives received very high
compensation despite the very poor performance by their firms.
For example, Mr. Charles O. Prince III, the former chief
executive of Citigroup, ``collected $110 million while
presiding over the evaporation of roughly $64 billion in market
value. He left Citigroup in November with an exit package worth
$68 million, including $29.5 million in accumulated stock, a
$1.7 million pension, an office and assistant, and a car and a
driver. Citigroup's board also awarded him a cash bonus for
2007 worth about $10 million, largely based on his performance
in 2006 when the bank's results were better. Citigroup has
announced write-offs worth roughly $20 billion and its share
has plummeted over 60 percent from last year's high.''\231\
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\231\``Chiefs' Pay Under Fire At Capitol,'' The New York Times,
March 8, 2008.
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Ms. Ann Yerger, representing the Council of Institutional
Investors, wrote in congressional testimony for the Committee
that ``the Council believes an annual, advisory shareowner vote
on executive compensation would efficiently and effectively
provide boards with useful information about whether investors
view the company's compensation practices to be in shareowners'
best interests. Nonbinding shareowner votes on pay would serve
as a direct referendum on the decisions of the compensation
committee and would offer a more targeted way to signal
shareowner discontent than withholding votes from committee
members. They might also induce compensation committees to be
more careful about doling out rich rewards, to avoid the
embarrassment of shareowner rejection at the ballot box. In
addition, compensation committees looking to actively rein in
executive compensation could use the results of advisory
shareowner votes to stand up to excessively demanding officers
or compensation consultants.''\232\
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\232\Protecting Shareholders and Enhancing Public Confidence by
Improving Corporate Governance: Testimony before the Subcommittee on
Securities, Insurance, and Investment of the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session,
(2009) (Testimony of Ms. Ann Yerger).
---------------------------------------------------------------------------
The UK has implemented ``say on pay'' policy. Professor
John Coates in testimony for the Senate Banking Committee
stated that the UK's experience has been positive; ``different
researchers have conducted several investigations of this kind
. . . These findings suggest that say-on-pay legislation would
have a positive impact on corporate governance in the U.S.
While the two legal contexts are not identical, there is no
evidence in the existing literature to suggest that the
differences would turn what would be a good idea in the UK into
a bad one in the U.S.''
Other observers who support ``say on pay'' include the
Consumer Federation of America, AFSCME, and the Investor's
Working Group.
Section 952. Compensation committee independence
Section 952 directs the SEC to direct the national
securities exchanges and national securities associations to
prohibit the listing of any security of an issuer that does not
comply with independent compensation committee standards. In
determining whether a director is independent, the national
securities exchanges should consider the source of compensation
of a member of the board of directors of an issuer, including
any consulting, advisory, or other compensatory fee paid by the
issuer to such member of the board of directors; and whether a
member of the board of directors of an issuer is affiliated
with the issuer, a subsidiary of the issuer, or an affiliate of
a subsidiary of the issuer. Any compensation counsel or adviser
shall be independent.
The issuer's proxy or consent materials must disclose
whether the compensation committee has used the advice of a
compensation consultant and whether the committee has raised
any conflict of interest. However, the provision does not
require the use of compensation consultants. The Section also
directs the SEC to conduct a study of the use of compensation
consultants and their impact. The Treasury Department's
legislative proposal included an independent compensation
committee.
The Council of Institutional Investors wrote in a letter to
Senator Dodd ``Compensation committees and their external
consultants play a key role in the pay-setting process.
Conflicts of interest contribute to a ratcheting up effect for
executive pay, however, and should thus be minimized and
disclosed. Reforms included in the discussion draft would help
ensure that compensation committees are free of conflicts and
receive unbiased advice.''
Section 953. Executive compensation disclosures
Section 953 directs the SEC to require each issuer to
disclose in the annual proxy statement of the issuer a clear
description of any compensation required to be disclosed under
the SEC executive compensation forms and information that shows
the relationship between executive compensation and the
financial performance of the issuers, taking into account the
change in the value of the shares, dividends and distributions.
It has become apparent that a significant concern of
shareholders is the relationship between executive pay and the
company's financial performance for the benefit of
shareholders. Shareholders are keenly interested when executive
compensation is increasing sharply at the same time as
financial performance is falling.
The Committee believes that these disclosures will add to
corporate responsibility as firms will have to more clearly
disclose and explain executive pay. Ms. Ann Yerger wrote in
congressional testimony on behalf of the Council of
Institutional Investors ``of primary concern to the Council is
full and clear disclosure of executive pay. As U.S. Supreme
Court Justice Louis Brandeis noted, `sunlight is the best
disinfectant.' Transparency of executive pay enables
shareowners to evaluate the performance of the compensation
committee and board in setting executive pay, to assess pay-
for-performance links and to optimize their role of overseeing
executive compensation through such means as proxy voting.''
This disclosure about the relationship between executive
compensation and the financial performance of the issuer may
include a clear graphic comparison of the amount of executive
compensation and the financial performance of the issuer or
return to investors and may take many forms. For example, a
graph could have a horizontal axis of a number of years and a
vertical axis with two scales, one for executive compensation
and a second for financial performance of the issuer for each
year.
Section 954. Recovery of erroneously awarded compensation
Section 954 requires public companies to have a policy to
recover money that they erroneously paid in incentive
compensation to executives as a result of material
noncompliance with accounting rules. This is money that the
executive would not have received if the accounting was done
properly and was not entitled to. This provision creates
Section 10D of the Securities Exchange Act of 1934, which
requires the SEC to direct the national securities exchanges
and national securities associations to prohibit the listing of
issuers who do not develop and implement a policy providing
that, in the event that the issuer is required to prepare an
accounting restatement due to the material noncompliance, the
issuer will recover from any current or former executive
officer of the issuer any compensation in excess of what would
have been paid to the executive officer had correct accounting
procedures been followed. This policy is required to apply to
executive officers, a very limited number of employees, and is
not required to apply to other employees. It does not require
adjudication of misconduct in connection with the problematic
accounting that required restatement.
The Committee believes it is unfair to shareholders for
corporations to allow executives to retain compensation that
they were awarded erroneously. This proposal will clarify that
all issuers must have a policy in place to recover compensation
based on inaccurate accounting so that shareholders do not have
to embark on costly legal expenses to recoup their losses or so
that executives must return monies that should belong to the
shareholders. The Investor's Working Group wrote ``federal
clawback provisions on unearned executive pay should be
strengthened.''\233\
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\233\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, July 2009.
---------------------------------------------------------------------------
Section 955. Disclosure regarding employee and director hedging
Section 955 directs the SEC to require each issuer to
disclose in the annual proxy statement whether the employees or
members of the board of the issuer are permitted to purchase
financial instruments that are designed to hedge or offset any
decrease in the market value of equity securities granted to
employees by the issuer as part of an employee compensation.
This will allow shareholders to know if executives are allowed
to purchase financial instruments to effectively avoid
compensation restrictions that they hold stock long-term, so
that they will receive their compensation even in the case that
their firm does not perform. Dr. Carr Bettis has written that
derivatives instruments ``provide a mechanism that insiders can
use to trade on inside information prior to adverse corporate
events without the level of transparency typically associated
with open market sales.''\234\
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\234\See Bettis, Bizjak and Kalpathy, ``Insiders' Use of Hedging
Instruments: An Empirical Examination,'' March 2009.
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Section 956. Excessive compensation by holding companies of depository
institutions
Section 956 amends Section 5 of the Bank Holding Company
Act of 1956 to establish standards prohibiting as an unsafe and
unsound practice any compensation plan of a bank holding
company that provides an executive officer, employee, director,
or principal shareholder with excessive compensation, fees, or
benefits; or could lead to material financial loss to the bank
holding company. This applies regulatory authority currently
applicable to banks to their holding companies.
Section 957. Voting by brokers
Section 957 amends the Securities Exchange Act of 1934 so
that brokers who are not beneficial owners of a security cannot
vote through company proxies unless the beneficial owner has
instructed the broker to do so. The final vote tallies should
reflect the wishes of the beneficial owners of the stock and
not be affected by the wishes of the broker that holds the
shares.
Subtitle F
Section 961. Report and certification of internal supervisory controls
Section 961 directs the SEC to submit a report on SEC's
conduct of examinations of registered entities, enforcement
investigations, and review of corporate financial securities
filings to the House Financial Services and Senate Banking
Committees. Each report should contain an assessment of the
SEC's internal supervisory controls and examination staff
procedures; a certification of adequate supervisory controls by
the Directors of the Divisions of Enforcement, Division of
Corporation Finance, and Office of Compliance Inspection and
Examinations; and a review by the U.S. Comptroller General
attesting to the adequacy and effectiveness of the internal
supervisory control structure and procedures.
The purpose of this Section is to promote complete and
consistent performance of SEC staff examinations,
investigations and reviews, and appropriate supervision of
these activities, through internal supervisory controls. There
have been numerous examples where securities misconduct has
flourished and investors have been harmed due to failure to
follow reasonable procedures. For example, the Inspector
General found that the Enforcement Office of the Chief
Accountant received numerous complaints alleging financial
fraud committed by a public company over 2\1/2\ years which
were ``not reviewed, analyzed or investigated'' because ``the
referral procedures for monitoring the progress of referrals of
complaints . . . were not followed in the 2005-2007 time
period. For example, regular meetings to decide the disposition
of referrals were being held.'' (SEC Office of Inspector
General Report of Investigation, ``Failure to Timely
Investigate Allegations of Financial Fraud,'' February 26,
2010).
The massive fraud perpetrated by Bernard L. Madoff through
a Ponzi scheme cost investors a tremendous amount of money and
went undetected through failures in SEC exams and
investigations. This illustrates the need for such internal
supervisory controls. The failure of the SEC (or of FINRA) to
identify the fraud before Mr. Madoff confessed to his sons and
to law enforcement seriously damaged investor confidence in the
effectiveness and competence of regulators. The Inspector
General of the SEC, Mr. David Kotz, testified before the
Committee about his study of the SEC's failure to find the
Madoff fraud. The study found ``that the SEC received more than
ample information in the form of detailed and substantive
complaints over the years to warrant a thorough and
comprehensive examination and/or investigation of Bernard
Madoff and BMIS for operating a Ponzi scheme, and that despite
three examinations and two investigations being conducted, a
thorough and competent investigation or examination was never
performed. The OIG found that between June 1992 and December
2008 when Madoff confessed, the SEC received six substantive
complaints that raised significant red flags concerning
Madoff's hedge fund operations and should have led to questions
about whether Madoff was actually engaged in trading. Finally,
the SEC was also aware of two articles regarding Madoff's
investment operations that appeared in reputable publications
in 2001 and questioned Madoff's unusually consistent returns.''
[IG Report pages 20-21]
Inspector General Kotz's comprehensive study found that on
several occasions during more than a decade, the SEC failed to
perform what appear to be rudimentary procedures that could or
would have uncovered the Ponzi scheme. The Inspector General
reported that the ``complaints all contained specific
information and could not have been fully and adequately
resolved without thoroughly examining and investigating Madoff
for operating a Ponzi scheme.'' [Page 22]. For example, the
Inspector General retained an expert to assist in the
investigation and was told that ``the most critical step in
examining or investigating a potential Ponzi scheme is to
verify the subject's trading through an independent third
party.'' The OIG investigation ``found the SEC conducted two
investigations and three examinations . . . based upon the
detailed and credible complaints that raised the possibility
that Madoff was misrepresenting his trading and could have been
operating a Ponzi scheme. Yet, at no time did the SEC ever
verify Madoff's trading through an independent third-party.''
The OIG found that the examinations were ``too narrowly
focused.'' The OIG found that ``the examination teams . . .
caught Madoff in contradictions and inconsistencies. However
they either disregarded these concerns or simply asked Madoff
about them. Even when Madoff's answers were seemingly
implausible, the SEC examiners accepted them at face value.''
[page 23]
``In the first of the two OCIE examinations, the examiners
drafted a letter to the National Association of Securities
Dealers . . . seeking independent trade data, but they never
sent the letter, claiming that it would have been too time-
consuming to review the data they would have obtained. The
OIG's expert opined that had the letter to the NASD been sent,
the data would have provided the information necessary to
reveal the Ponzi scheme. In the second examination, the OCIE
Assistant Director sent a document request to a financial
institution that Madoff claimed he used to clear his trades,
requesting trading done by or on behalf of particular Madoff
feeder funds during a specific time period, and received a
response that there was no transaction activity in Madoff's
account for that period. However, the Assistant Director did
not determine that the response required any follow-up . . .
Both examinations concluded with numerous unresolved questions
and without any significant attempt to examine the possibility
that Madoff was misrepresenting his trading and operating a
Ponzi scheme.'' [page 24]
The ``Enforcement staff almost immediately caught Madoff in
lies and misrepresentations, but failed to follow up on
inconsistencies. . . . When Madoff provided evasive or
contradictory answers to important questions in testimony, they
simply accepted as plausible his explanations . . . They
reached out to the NASD and asked for information on whether
Madoff had options positions on a certain date, but when they
received a report that there were in fact no options positions
on that date, they did not take further steps. An Enforcement
staff attorney made several attempts to obtain documentation
from European counterparties (another independent third-party)
and although a letter was drafted, the Enforcement staff
decided not to send it. Had any of these efforts been fully
executed, they would have led to Madoff's Ponzi scheme being
uncovered.''
In addition, the incidents of courts overturning SEC
rulemakings in recent years calls into question whether the
process by which the SEC is promulgating final rules should be
reexamined and refined. The SEC's process for reaching
settlement recommendations may need to be reexamined also, in
light of the recent decision of the Federal District Court in
New York that rejected as inadequate a proposed $33 million
settlement involving charges of securities fraud against Bank
of America which it said ``does not comport with the most
elementary notions of justice and morality . . . [and] suggests
a rather cynical relationship between the parties: the SEC gets
to claim that it is exposing wrongdoing on the part of the Bank
of America in a high-profile merger; the Bank's management gets
to claim that they have been coerced into an onerous settlement
by overzealous regulators. And all of this is done at the
expense, not only of the shareholders, but also of the
truth.''\235\ Internationally renowned Columbia University
Professor John C. Coffee has expressed concerns about what he
has seen as ``dysfunction in SEC enforcement practices.''\236\
Recently, the SEC Office of Inspector General Report of
Investigation published a report, ``Investigation of the SEC's
Response to Concerns Regarding Robert Allen Stanford's Alleged
Ponzi Scheme'' which found that over eight years an SEC office
``dutifully conducted examinations of Stanford in 1997, 1998,
2002 and 2004, concluding in each case that Stanford's CDs were
likely a Ponzi scheme or a similar fraudulent scheme. . . .
[while the] Examination group made multiple effort after each
examination to convince . . . [Enforcement] to open and conduct
an investigation of Stanford, no meaningful effort was made by
Enforcement to investigate the potential fraud or to bring an
actions to attempt to stop it until late 2005.
---------------------------------------------------------------------------
\235\The case is Securities and Exchange Commission v. Bank of
America Corp., 09-cv-06829, U.S. District Court, Southern District of
New York (Manhattan).
\236\The End of Phony Deterrence? `SEC v. Bank of America', John C.
Coffee, Jr., New York Law Journal, September 17, 2009.
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Section 962. Triennial report on personnel management
Section 962 directs the GAO to submit a triennial report to
the Committee on Banking, Housing, and Urban Affairs of the
Senate and the Committee on Financial Services of the House of
Representatives on personnel management by the SEC. In the wake
of the financial crisis, it is clear that the SEC, along with
other federal regulators, did not perform its duties as
intended. The study would review several areas that have been
implicated, including supervision, competence, communication,
turnover, and other areas, with recommendations for
improvements. Within 90 days the SEC will submit a report to
these congressional Committees describing what actions it has
taken in response to the GAO report.
The SEC has been receiving increased amounts of funds and
is expected to continue to do so. It is critical that these
funds be used efficiently and not wasted. These studies will
promote the effective use of resources.
Mr. Damon Silvers, Associate General Counsel of the AFL-
CIO, wrote in congressional testimony that ``The Commission
should look at more intensive recruiting efforts aimed at more
experienced private sector lawyers who may be looking for
public service opportunities.''\237\
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\237\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, pp. 5-6 (2009)
(Testimony of Mr. Damon A. Silvers).
---------------------------------------------------------------------------
The Investor's Working Group wrote in their regulatory
reform report ``Regulators should acquire deeper knowledge and
expertise. The speed with which financial products and services
have proliferated and grown more complex has outpaced
regulators' ability to monitor the financial waterfront.
Staffing levels failed to keep pace with the growing work load,
and many agencies lack staff with the necessary expertise to
grapple with emerging issues. Political appointees and senior
civil service staff should have a wide range of financial
backgrounds. Compensation should be sufficient to attract top-
notch talent. In addition, continuing education and training
should be dramatically expanded and officially mandated to help
regulators keep pace with innovation.''\238\
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\238\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, p. 10, July 2009.
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The reports should address key management issues. Renowned
Columbia University Law School Professor John C. Coffee said an
important ``issue is how to change the SEC's culture.''\239\
Senator Merkley at the Madoff IG hearing asked about SEC
employees involved, ``Was there a general culture of a lack of
curiosity, a lack of wanting to inconvenience big players . . .
What are the managerial issues?''\240\ Information in the SEC
Inspector General's report on the Madoff investigation raises
concerns about whether some employees who had been promoted to
serve as mid-level supervisors had the necessary judgment,
commitment or temperament to be effective supervisors. This
suggests questions about the appropriateness of how employees
are promoted to supervisory positions. One indication of a
supervisor's ineffectiveness may be high turnover among
subordinates. Related to this issue, the Committee notes that
the Division of Enforcement will eliminate the position of
branch chief. The stated purpose ``is to streamline our
management structure . . . by redeploying our branch chiefs . .
. to the heart-and-soul function of the SEC--conducting
investigations. This flattening of our management structure
will increase the resources dedicated to our investigative
efforts, and will operate as a check on the extra process,
duplication, unnecessary internal review and the inevitable
drag on decision-making that happens in any overly-managed
organization.'' The Committee sees this as a positive step,
which suggests the question of whether there are excessive
numbers of low- or mid-level managers in other divisions and
similar steps should be taken to improve the effectiveness and
better use the resources of those divisions.
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\239\The End of Phony Deterrence? `SEC v. Bank of America', John C.
Coffee, Jr., New York Law Journal, September 17, 2009.
\240\``Oversight of the SEC's Failure to Identify the Bernard L.
Madoff Ponzi Scheme and How to Improve SEC Performance: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs'', 111th Congress, 1st session, p. 33 (2009) (Statement of
Senator Jeff Merkley).
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Members of the Committee noted that it was some SEC
employees' apparent incompetence that allowed the Madoff fraud
to continue for so long--a case of incompetence and not lack of
resources or legal authority. For example, Senator Menendez
said that ``the SEC staff was, from everything I've read of
your report, grossly untrained, uncoordinated and lazy in their
investigations.'' He asked ``who's held accountable for these
grossly incompetent performances?''\241\ This raises a concern
to review SEC response to employees who fail to perform their
duties. The IG report also identifies a concern that SEC-
regulated entities have on many occasions brought informally to
the attention of the Committee in other contexts, that
different offices within the Commission do not communicate
effectively or, at times, willingly, with each other to share
expertise. Former SEC Chairman William Donaldson embarked upon
a project to ``tear down the silos'' and promote more
communication. Some regulated entities have informally
complained to the Committee that the SEC inspectors arrive on
their premises with a limited knowledge of the business they
are about to inspect, and ask the employees of the regulated
entity to teach them how their businesses operate. It would be
appropriate for formal reviews of the efficiency of
communication between units of the Commission.
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\241\``Oversight of the SEC's Failure to Identify the Bernard L.
Madoff Ponzi Scheme and How to Improve SEC Performance: Testimony
before the U.S. Senate Committee on Banking, Housing, and Urban
Affairs'', 111th Congress, 1st session, p. 33 (2009) (Statement of
Senator Robert Menendez).
---------------------------------------------------------------------------
Since the concerns identified here, and related ones, have
faced the Commission for many years, the Committee feels it is
important to have periodic studies by and recommendations from
the GAO with the goal of sustaining improvements at the
Commission.
Section 963. Annual financial controls audit
Section 963 directs the SEC to submit an annual report to
Congress that describes the responsibility of the management of
the SEC for establishing and maintaining an adequate internal
control structure and procedures for financial reporting; and
contains an assessment of the effectiveness of the internal
control structure and procedures for financial reporting of the
SEC during that fiscal year. This is intended to improve the
quality of the SEC's internal financial control structure.
The SEC administers the requirements under Section 404 of
the Sarbanes-Oxley Act of 2002 that public companies report on
the effectiveness of their internal control structure and
procedures for financial reporting. Public companies need
effective internal controls in order to produce accurate
financial reports, confidently plan their financial activities,
and inspire the confidence of investors in the integrity of
public companies and in the securities markets.
As the Federal regulator of compliance with these
requirements, it is appropriate for the SEC itself to be an
example and have an effective internal financial control
structure and for that to be attested to. Unfortunately, the
SEC has been found to have material weaknesses in its own
internal financial controls.
The GAO has reviewed the SEC's internal financial controls
since 2004. In many of these reviews, the GAO has found that
the SEC has material weaknesses and needs improvement in their
internal control structure. GAO stated in November of 2009 that
``in GAO's opinion, SEC did not have effective internal control
over financial reporting as of September 30, 2009. . . . During
this year's audit, we identified six significant deficiencies
that collectively represent a material weakness in SEC's
internal control over financial reporting. The significant
deficiencies involve SEC's internal control over (1)
information security, (2) financial reporting process, (3) fund
balance with Treasury, (4) registrant deposits, (5) budgetary
resources, and (6) risk assessment and monitoring processes.
These internal control weaknesses give rise to significant
management challenges that have reduced assurance that data
processed by SEC's information systems are reliable and
appropriately protected; impaired management's ability to
prepare its financial statements without extensive compensating
manual procedures; and resulted in unsupported entries and
errors in the general ledger.''\242\ Similarly, the GAO has
found that the SEC did not have effective internal controls
over financial reporting as of September 30, 2004, 2005, and
2007. In light of these persistent shortcomings and the
importance of the SEC, an annual review is appropriate and
beneficial.
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\242\Securities and Exchange Commission's Financial Statements for
Fiscal Years 2009 and 2008, GAO, ``Highlights,'' November 2009.
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Section 964. Report on oversight of national securities associations
Section 964 provides that, once every three years, the GAO
shall study and submit a report to Congress on the SEC's
oversight of national securities associations (NSA). The report
is intended to promote regular and effective oversight by the
SEC of the NSA and to inform the Congress in its oversight role
of the Nation's securities markets. Such oversight is important
to assist and promote the NSA's performance of its mission and
fair dealing with investors and members and to evaluate any
public concerns that arise.
It is the Committee's intent that the SEC should oversee
specifically several important functions which have been
discussed in connection with the current market situation.
These matters include an evaluation of governance, including
the identification and management of conflicts of interest,
such as those existing when an executive of a broker-dealer
sits on an NSA board and the NSA enforces its rules on such
firms; examinations, including the evaluation of the expertise
of staff; executive compensation practices; the extent of
cooperation with and responsiveness in providing assistance to
State securities administrators; funding; arbitration services,
which may include enforcement of discovery rules and fairness
of selection process for arbitrators on the panel, and NSA
review of member advertising.
Former SEC Chief Accountant Lynn Turner testified on March
10, 2009 that:
FINRA has been a useful participant in the capital
markets. It has provided resources that otherwise would
not have been available to regulate and police the
markets. Yet serious questions have arisen that need to
be considered when improving the effectiveness and
efficiency of regulation.
Currently the Board of FINRA includes representatives
from those who are being regulated. This is an inherent
conflict and raises the question of whose interest the
Board of FINRA serves. To address this concern,
consideration should be given to establishing an
independent board, much like what Congress did when it
established the Public Company Accounting Oversight
Board.
In addition, the arbitration system at FINRA has been
shown to favor the industry, much to the detriment of
investors. While arbitration in some instances can be a
benefit, in others it has been shown to be costly, time
consuming, and biased to those who are constantly
involved with it. Accordingly, FINRA's system of
arbitration should be made optional, and investors
given the opportunity to pursue their case in a court
of law if they so desire to do so.
Finally careful consideration should be given to
whether or not FINRA should be given expanded powers
over investment advisors as well as broker dealers.
FINRA's drop in fines and penalties in recent years,
and lack of transparency in their annual report to the
public, raises questions about its effectiveness as an
enforcement agency and regulator. And with broker
dealers involved in providing investment advice, it is
important that all who do so are governed by the same
set of regulations, ensuring adequate protection for
the investing public.
The Committee has received letters from groups that have
raised numerous concerns about the performance of FINRA,
expressing concern that they ``have failed to prevent virtually
all of the major securities scandals since the 1980s,'' their
compensation packages for the organization's senior executives
are ``outrageous'' for their large size, they failed to warn
the public about auction rate securities and other reasons. The
Committee believes it is necessary for the GAO to conduct a
study and issue a report on the SEC oversight of national
securities associations at least every three years given their
important role in the market and the concerns which have arisen
or persisted for many years.
Section 965. Compliance examiners
Section 965 directs the SEC Divisions of Trading and
Markets and of Investment Management each to have a staff of
examiners to perform compliance inspections and examinations of
entities under their jurisdictions and report to the Director
of the Division. This is intended to improve the effectiveness
of the SEC. This will provide each Division internally with
experts in inspections and in the regulations of that Division,
who are closely acquainted with and have access to the staff
who write and interpret those regulations.
The Inspector General's report on the Madoff investigation
and the testimony of Mr. Harry Markopolos, for example, were
critical of the competence and training of the examiners,
including their unwillingness to ask for information or
expertise from someone in another SEC division. Mr. David G.
Tittsworth, Executive Director of the Investment Adviser
Association, wrote in testimony for the Senate Banking
Committee that ``the SEC can and should improve its inspection
program.''\243\ Informal information presented to the Committee
from regulated entities has indicated that the Office of
Compliance Inspection and Examinations sometimes sends staff on
examinations who have lacked requisite expertise to examine
complex registered financial or securities firms. As a result,
the quality of the exams appears to have suffered, the staff
may have taken undue amounts of time to perform inspections
because they relied excessively on the employees of the firms
being examined to teach them about the business, and the
reputation of the agency has suffered.
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\243\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. David Tittsworth).
---------------------------------------------------------------------------
Section 966. Suggestion program for employees of the commission
Section 966 directs the SEC Inspector General to establish
a hotline for SEC employees to submit suggestions for
improvements in the efficiency, effectiveness, productivity and
use of resources of the SEC, as well as allegations of waste,
abuse, misconduct or mismanagement within the SEC. The
Inspector General shall maintain as confidential the identity
of a person who provides information unless he or she requests
otherwise in writing and any specific information at the
person's request. The Inspector General will report to Congress
annually on the nature, number and potential benefits of the
suggestions of any suggestions; the nature, number and
seriousness of any allegations; the Inspector General's
recommendations and actions taken in response to the
allegations; and actions the SEC has taken in response to the
suggestions and allegations.
The SEC would benefit by having more meritorious
suggestions from its employees on how to improve efficiency and
productivity. This is particularly important when the SEC will
be receiving larger budgets and after a period of increased
public concerns about the agency's ineffective use of resources
raised in Madoff, restacking, and in other situations. It is
not clear that the current system for attracting suggestions to
improve productivity has been producing a robust crop of
meritorious suggestions.
The Committee expects that there will be review and
appropriate action on meritorious suggestions. The Inspector
General may recognize an employee who makes a suggestion that
would or does increase efficiency, effectiveness or
productivity at the SEC or reduces waste, abuse, misconduct or
mismanagement. The costs of this Suggestion Program shall be
funded by the SEC Investor Protection Fund. Nothing in this
section limits other statutory authorities of the Inspector
General.
This Program is placed within the Office of the Inspector
General, which has a tradition of analyzing agency activity to
prevent abuse and promote effective operations. The IG already
has a formal system in place for receiving employee complaints
which can be adapted to receive suggestions. Further, the
Office of Inspector General has a reputation for keeping
employee confidences and is not in the normal chain of command
in the SEC, so that employees may feel more confident that they
can offer suggestions confidentially and without the risk of
retaliation by a supervisor. The Inspector General is
sufficiently independent from the daily SEC staff interactions
for employees to trust his impartiality in deciding rewards.
The Office of IG will have few potential conflicts of interest
in reviewing suggestions compared to other SEC offices. The
Committee observes that the SEC already has the authority to
run a suggestion program and has discretion to make cash
awards, so it would not need legislative authority to do so.
The Committee has considered whether a Suggestion Program
must offer monetary rewards that are sufficiently large to
motivate employees to make meritorious and valuable
suggestions, and to overcome fears of offending or annoying a
supervisor or of retribution. The Committee hopes that the
Suggestion Program would motivate employees to produce
meaningful suggestions for the benefit of the SEC.
Subtitle G
Section 971. Election of directors by majority vote in uncontested
elections
Section 971 provides that if a majority of a public
company's shares are voted against or withheld from a nominee
for director who runs uncontested, or without an opponent, he
or she should be required to resign, unless the board
unanimously finds it is in the best interest of the
shareholders for him or her to serve and publishes its
reasoning. It does this by requiring the SEC to direct the
national securities exchanges and national securities
associations to prohibit the listing of any security of an
issuer who has on their board members that did not receive a
majority vote in uncontested board elections, subject to an
exception if the directors unanimously voted that it is in the
best interests of the shareholders that the director serve.
The Committee believes that in the uncommon circumstance
where a majority of shareholders voting in an uncontested
election prefer that a nominee not serve on the board, it is
fair and appropriate for their wishes to be honored. Currently,
an uncontested nominee who receives even one vote would be
elected as a director of many companies.
The Committee has received many views on this matter.
Former SEC Chief Accountant Lynn Turner testified that Congress
should ``[r]equire majority voting for directors and those who
can't get a majority of the votes of investors they are to
represent should be required to step down.''\244\ Ms. Barbara
Roper, Director of Investor Protection of the Consumer
Federation of America also testified in favor of requiring
``mandatory majority voting for directors.''\245\ The Council
of Institutional Investors, a nonprofit association of public,
union and corporate pension funds with combined assets that
exceed $3 trillion, favors majority voting stating:
``Currently, the accountability of directors at most US
companies is severely weakened by the fact that shareowners do
not have a meaningful vote in director elections. Under most
state laws, including Delaware, the default standard for
uncontested elections is a plurality vote, which means that a
director is elected even if a majority of the shares are
withheld from the nominee. The Council has long believed that a
plurality standard for the uncontested election of directors is
inherently unfair and undemocratic and should be replaced by a
majority vote standard. In recent years, many companies,
including more than two-thirds of the S&P 500 have agreed with
the Council and have voluntarily adopted majority voting
standards. At most public companies, however, plurality voting
still remains the rule. For example, nearly three-quarters of
the companies in the Russell 3000 continue to use a straight
plurality voting standard for director elections. The benefits
of moving to a majority voting standard are many: it would
democratize the corporate electoral process; put real voting
power in the hands of investors; and make boards more
representative of shareowners. Simply stated, Section 971, if
enacted, would eliminate a fundamental flaw in the US
governance model.''\246\
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\244\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Lynn Turner).
\245\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Ms. Barbara Roper).
\246\Letter to Chairman Dodd, March 19, 2010.
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The Committee has also heard from those who are concerned
and believe that some directors who fail to receive the vote of
a majority of shareholders should nonetheless serve on the
board. Such an individual might be, for example, the board's
only financial expert or a person with unique expertise.
The Committee has taken this type of concern into account.
The legislation would allow a director who received less than a
majority of votes to serve on the board if the remaining board
members unanimously vote at a board meeting that it is in the
best interests of the issuer and its shareholders not to accept
the resignation. When the issuer publishes this decision, it
should include a specific discussion of the board's analysis in
reaching that conclusion. Such publication may be made in a
filing made with the SEC.
Section 972. Proxy access
Section 972 was introduced by Senator Schumer. It gives the
SEC the authority to require issuers to allow shareholders to
put Board nominees on the company proxy. It does not require
the SEC to engage in rulemaking. The authority gives the SEC
wide latitude in setting the terms of such proxy access.
The Committee intentionally did not specify that
shareholders must have held a certain number of shares or have
held shares for a particular period of time to be eligible to
use the proxy. If the SEC proposes rules, interested persons
can offer their views on the appropriateness of proposed
regulatory terms in the public comment process.
The Committee feels that it is proper for shareholders, as
the owners of the corporation, to have the right to nominate
candidates for the Board using the issuer's proxy under limited
circumstances.
Former SEC Chairman Richard Breeden testified before the
Committee in favor of one form of proxy access and recommended
to ``Allow the five (or ten) largest shareholders of any public
company who have owned shares for more than one year to
nominate up to three directors for inclusion on any public
company's proxy statement. Overly entrenched boards have widely
failed to protect shareholder interests for the simple reason
that they sometimes think more about their own tenure than the
interests of the people they are supposed to be protecting . .
. This provision would give `proxy access' to shareholder
candidates without the cost and distraction of hostile proxy
contests. At the same time, any such nomination would require
support from a majority of shares held by the largest holders,
thereby protecting against narrow special interest campaigns.
This reform would make it easier for the largest shareowners to
get boards to deal with excessive risks, poor performance,
excessive compensation and other issues that impair shareholder
interests.'' Ms. Barbara Roper, Director of Investor Protection
of Consumer Federation of America, testified before the
Committee and recommended ``improved proxy access for
shareholders.'' Mr. Jeff Mahoney, General Counsel of the
Council of Institutional Investors, wrote in a letter to
Chairman Dodd that ``the only way that shareowners can present
alternative director candidates at a U.S. public company is by
waging a full-blown election contest. For most investors, that
is onerous and prohibitively expensive. A measured right for
investors to place their nominees for directors on the
company's proxy card would overcome these obstacles,
invigorating board elections and making directors more
responsive, thoughtful and vigilant.'' Former SEC Chief
Accountant Lynn Turner testified before the Committee that
``Congress should move to adopt legislation that would: . . .
Give investors who own the company, the same equal access to
the proxy as management currently has.'' A coalition of state
public officials in charge of public investments, AFSCME,
CalPERS, and the Investor's Working Group also support proxy
access.
Section 973. Disclosures regarding Chairman and CEO structures
Section 973 directs the SEC to issue rules that require an
issuer to disclose the reasons that it has chosen the same
person or elected to have different people serve in the offices
of Chairman of the Board of Directors and Chief Executive
Officer of the issuer.
The Committee has received strong views on the merits of
one or the other model and on whether to prohibit a public
company from having the same individual serve as Chairman and
as CEO. For example, Mr. Joseph Dear, Chief Investment Officer
of the California Public Employees' Retirement System, on
behalf of the Council of Institutional Investors, wrote in
testimony for the Senate Banking Committee that ``Boards of
directors should be encouraged to separate the role of chair
and CEO, or explain why they have adopted another method to
assure independent leadership of the board.''
The Committee feels this is an important matter, and
recognizes that different public companies may have good
reasons for having the same person as CEO and Chairman or
different persons in these two positions. Accordingly, the
legislation asks public companies to disclose to shareholders
the reasons why it has chosen its governance method. The
legislation does not endorse or prohibit either method.
Subtitle H
Section 975. Regulation of municipal securities and changes to the
board of the MSRB
Section 975 strengthens oversight of municipal securities
and broadens current municipal securities market protections to
cover previously unregulated market participants and previously
unregulated financial transactions with states, counties,
cities and other municipal entities. This section establishes
municipal advisors as a new category of SEC registrant. Such
municipal advisors provide advice to municipal entities on the
issuance of municipal securities, the use of municipal
derivatives, and investment advice relating to bond proceeds.
Mr. Timothy Ryan, President and CEO of SIFMA, in testimony
before the Committee, said: ``we feel it is important to level
the regulatory playing field by increasing the Municipal
Securities Rulemaking Board's authority to encompass the
regulation of financial advisors, investment brokers and other
intermediaries in the municipal market to create a
comprehensive regulatory framework that prohibits fraudulent
and manipulative practices; requires fair treatment of
investors, state and local government issuers of municipal
bonds and other market participants; ensures rigorous standards
of professional qualifications; and promotes market
efficiencies.''\247\ Mr. Ronald A. Stack, Chair of the
Municipal Securities Rulemaking Board (MSRB), wrote in
testimony for the Senate Banking Committee:
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\247\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, pp. 9-10
(2009) (Testimony of Mr. Timothy Ryan).
Investors in the municipal securities market would be
best served by subjecting unregulated market
professionals to a comprehensive body of rules that (i)
prohibit fraudulent and manipulative practices, (ii)
require the fair treatment of investors, issuers, and
other market participants, (iii) mandate full
transparency, (iv) restrict real and perceived
conflicts of interests, (v) ensure rigorous standards
of professional qualifications, and (vi) promote market
efficiencies.\248\
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\248\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p. 25
(2009) (Testimony of Mr. Ronald A. Stack).
The U.S. Council of Mayors\249\ also testified in support of
this policy.
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\249\Legislative Proposals to Improve the Efficiency and Oversight
of Municipal Finance: Testimony before the U.S. House Committee on
Financial Services, 111th Congress, 1st session (2009) (Testimony of
The Honorable Thomas C. Leppert).
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The SEC recently proposed new rules under the Investment
Advisers Act of 1940 relating to the provision by registered
investment advisers of investment advisory services to
municipal entities in which, among other things, the SEC
proposed prohibiting investment advisers from making payments
to unrelated persons for solicitation of municipal entities for
investment advisory services on behalf of investment advisers.
Rather than effectively prohibiting such third-party
solicitation for investment advisory services, this section
would provide that activities of a municipal advisor, broker,
dealer or municipal securities dealer to solicit a municipal
entity to engage an unrelated investment adviser to provide
investment advisory services to a municipal entity or to engage
to undertake underwriting, financial advisory or other
activities for a municipal entity in connection with the
issuance of municipal securities, would be subject to
regulation by the MSRB. These activities of municipal advisors
are currently unregulated in most respects and would become
subject to regulation by the MSRB to the same extent as would
such activities undertaken by brokers, dealers and municipal
securities dealers with respect to their transactions in
municipal securities. Thus, the MSRB would be authorized to
establish qualification requirements, continuing education and
operational standards, and fair practice, disclosure, conflict
of interest and other rules with respect to municipal advisors
in the same manner as for brokers, dealers and municipal
securities dealers.
Section 975 authorizes the MSRB to make rules regulating
municipal advisors, including financial advisors, brokers of
guaranteed investment contracts and other investments, swap and
other municipal derivatives advisors, and certain third party
solicitors of municipal entities. The Committee believes that
giving MSRB rulemaking authority in this area is an efficient
use of regulatory resources, particularly since the SEC
currently has very few staff with expertise in municipal
securities. Not only does the MSRB have greater resources in
terms of personnel and experience in the municipal market. The
Board has an existing, comprehensive set of rules on key issues
such as pay-to-play and fair dealing. Therefore, the Committee
is of the view that consistency would be important to ensure
common standards. As a baseline for rulemaking with respect to
municipal advisors, the MSRB has an extensive understanding of
the municipal securities market and has put in place a mature
body of comprehensive regulation that (i) prohibits fraudulent
and manipulative practices, (ii) requires the fair treatment of
investors, issuers and other market participants, (iii)
mandates full transparency, (iv) restricts real and perceived
conflicts of interests, including prohibiting pay-to-play
practices, (v) ensures rigorous standards of professional
qualifications, and (vi) promotes market efficiencies. The
rules for municipal advisory activities would apply equally to
broker-dealers acting as financial advisors and to non-
affiliated financial advisors. The Committee also notes that
the MSRB has made important contributions to the transparency
of the municipal market with its EMMA online reporting system.
The SEC has general oversight authority over the MSRB, and
would enforce the municipal advisor rules issued pursuant to
this section. The MSRB's rulemaking process, including a public
comment process and SEC approval of all new rules, provides
another layer of protection regarding the appropriateness of
rules written by the MSRB. The section creates an expanded role
for the MSRB in supporting SEC examinations and enforcement;
gives the MSRB a share of fines collected by the SEC and FINRA;
and gives the MSRB authority to be an information repository
for the systemic risk regulator.
This section also modifies the composition of the MSRB, in
light of the expansion of the Board's jurisdiction and to avoid
conflicts of interest. Under current law, 10 of the 15 board
members represent the securities dealers and underwriters that
are regulated by the MSRB. With the expansion of the MSRB's
jurisdiction to include municipal advisors, it is appropriate
to provide for majority public representation. The section
provides that the MSRB shall include 8 individuals who are not
associated with broker-dealers, municipal advisors, or
municipal securities dealers, and 7 individuals who are
associated with broker-dealers, municipal advisors, or
municipal securities dealers. The 8 public members will include
at least one investor representative, one representative of
municipalities, and a member of the public with knowledge or
experience in the municipal securities field. As reconstituted
under this Section, the MSRB would not be dominated by members
having exclusive legal obligations to investors, given the
requirement for majority public membership as well as required
representation of regulated municipal advisors. Further, the
section would establish an explicit MSRB statutory mandate to
protect municipal entities, as well as investors.
The Section also provides that the MSRB, in conjunction
with or on behalf of other Federal financial regulators or
self-regulatory organizations, may establish information
systems and assess reasonable fees to support those information
systems.
Section 976. Government Accountability Office study of increased
disclosure to investors
Section 976 directs the GAO to conduct a study and review
of the disclosure required to be made by issuers of municipal
securities and report on the findings. The GAO will describe
the size of the municipal securities markets and the issuers
and investors; compare the disclosure regimes applicable to
issuers of municipal versus corporate bonds; evaluate the costs
and benefits to issuers of municipal securities of requiring
additional financial disclosures to investors; and make
recommendations relating to the repeal of the Tower Amendment,
which bars the MSRB and the SEC from imposing disclosure
requirements on municipal issuers.
The Committee believes that to improve investor protection
there is merit in considering the revocation of the Tower
Amendment, but that this move is significant and deserves a
deliberate study before action is taken. In support of
repealing the Tower Amendment, former SEC Chief Accountant Lynn
Turner wrote in testimony for the Senate Banking Committee
``there is a gap in regulation of the municipal securities
market as a result of what is known as the Tower Amendment.
Recent SEC enforcement actions such as with the City of San
Diego, the problems in the auction rate securities, and the
lurking problems with pension obligation bonds, all cry out for
greater regulation and transparency in these markets. As a
result, these token regulated markets now amount to trillions
of dollars and significant risks. Accordingly, as former
Chairman Cox recommended, I believe Section 15B(d)--Issuance of
Municipal Securities--of the Securities Act of 1934 should be
deleted.''\250\ The Investment Company Institute,\251\
Municipal Market Advisers,\252\ and former SEC Chairman Arthur
Levitt\253\ support increased disclosure by municipalities.
---------------------------------------------------------------------------
\250\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session, p. 11 (2009)
(Testimony of Mr. Lynn Turner).
\251\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Paul Schott Stevens).
\252\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Thomas G. Doe).
\253\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Arthur Levitt).
---------------------------------------------------------------------------
Section 977. Government Accountability Office study on the municipal
securities markets
Section 977 directs the GAO to conduct a study and issue a
report on the municipal securities markets, to include an
analysis of the mechanisms for trading, reporting, and settling
transactions; the needs of the markets and investors and the
impact of recent innovations; potential uses of derivatives in
the municipal markets; and recommendations to improve the
transparency, efficiency, fairness, and liquidity of the
municipal securities market. The GAO shall submit its report to
the Committee on Banking, Housing, and Urban Affairs of the
Senate, the Financial Services Committee of the House of
Representatives, with a copy to the Special Committee on Aging
of the Senate, within 180 days of the enactment of this Act.
Section 978. Study of funding for Government Accounting Standards Board
Section 978 requires the SEC to study the funding of the
Government Accounting Standards Board (GASB). GASB establishes
accounting principles that are used by many states and local
governments. As a result, GASB plays an important role in the
municipal securities market by providing the foundation for
financial reporting that investors rely on to make investment
decisions. GASB is currently funded by voluntary contributions
from states, local governments, and the financial community,
and through the sale of its publications, to meet its annual
budget of less than $8 million.
The Committee is concerned that such voluntary funding
arrangements can cause undue uncertainty and potentially lead
to the compromise of the GASB standard setting process. The
Banking Committee faced and solved a similar problem in 2002,
when the Financial Accounting Standards Board, which had been
relying on voluntary contributions and materials sales, was
given a secure funding mechanism through Section 109 of the
Sarbanes-Oxley Act.
The municipal securities market is an important component
of the Nation's capital markets, as it finances infrastructure
and other government needs, while at the same time providing
generally low-risk investment opportunities to Americans. There
are over 50,000 issuers of municipal securities, with more than
$2.8 trillion of United States municipal securities
outstanding. In 2008, over $450 billion of new municipal
securities were issued and nearly $5 trillion in municipal
securities were traded.
In this regard, the Committee is concerned that the current
funding mechanism may not ensure that GASB can produce high-
quality, unbiased, and transparent governmental accounting and
financial reporting standards.
This section requires the SEC to conduct a study that
evaluates: the role and importance of GASB in the municipal
securities markets; the manner in which GASB is funded and how
such manner of funding affects the financial information
available to securities investors; the advisability of changes
to the manner in which GASB is funded; and whether legislative
changes to the manner in which GASB is funded are necessary for
the benefit of investors and in the public interest. In
conducting the study, the SEC shall consult with State and
local government officers.
In considering the ``advisability'' of changes to the
funding, the Committee expects the SEC to evaluate alternative
methods, including methods that would provide GASB with
certainty about its income to meet its budget. In addition, the
SEC may consider whether it would be feasible or efficient for
a private entity, such as a self-regulatory organization, to
assess a fee from its members that underwrite municipal
securities offerings or whether it would be appropriate to
assess fees on secondary market transactions. The SEC is
required to submit the study to the Committee on Banking,
Housing, and Urban Affairs of the Senate and the Committee on
Financial Services of the House of Representatives within 270
days of the date of enactment.
Section 979. Commission Office of Municipal Securities
Section 979 establishes an Office of Municipal Securities
in the SEC to administer the Commission's rules with respect to
municipal securities dealers, advisors, investors, and issuers.
The Director of the Office shall report to the Chairman of the
Commission. The Office shall coordinate with the MSRB for
rulemaking and enforcement actions, and shall have sufficient
staff to carry out the requirements of this section, including
individuals with knowledge and expertise in municipal finance.
The Committee is concerned that the SEC has reduced the number
of staff in its municipal securities office over the past few
decades, and expects that the creation of the Office will allow
the SEC to devote increased supervisory attention to the
municipal market.
Subtitle I
Section 981. Authority to share certain information with foreign
authorities
Section 102(a) of the Sarbanes-Oxley Act of 2002 (``the
Act'') makes it unlawful for any public accounting firm to
prepare or issue, or participate in the preparation or
issuance, of any audit reports with respect to any issuer
without being registered with the Public Company Accounting
Oversight Board (``PCAOB''). As of January 1, 2010, 2,349 firms
were registered with the PCAOB, including 936 firms in 88 non-
U.S. jurisdictions. Many of those non-U.S. firms regularly
provide audit reports for issuers and are therefore inspected
by the PCAOB on a regular basis. As of March 31, 2010, the
Board has conducted 226 non-U.S. inspections located in 33
jurisdictions.
In conducting inspections abroad, the Board has sought to
coordinate and cooperate with local authorities. The Board has
said that its cooperative efforts have been impeded by the
Board's inability to share with its non-U.S. counterparts
confidential information related to the Board's oversight
activities. The list of authorities that may receive such
information is limited to the SEC, the Attorney General of the
United States, appropriate federal functional regulators, state
attorneys general in connection with criminal investigations,
and appropriate state regulatory agencies (such as state boards
of accountancy). These provisions, therefore, limit the PCAOB's
ability to share such information with other regulators,
including non-U.S. regulators.
A significant number of non-U.S. audit regulators have
cited this limitation as a reason for not cooperating with
PCAOB inspections and discouraging or prohibiting PCAOB-
registered firms in their jurisdictions from cooperating. For
example, the EU Directive on statutory audits permits
cooperation only if reciprocal working relationships have been
established between the member state's audit regulator and the
PCAOB. The European Commission has asserted that these working
relationships require that the PCAOB and the EU member state's
auditor regulator be able to engage in a mutual exchange of
inspection related information including audit working papers.
Section 981 will allow the PCAOB to share confidential
inspection and investigative information with foreign audit
oversight authorities under specified circumstances. The
sharing may occur if (1) the PCAOB makes a finding that it is
necessary to accomplish the purposes of the Act of to protect
investors in U.S. issuers; (2) the foreign authority has:
provided the assurances of confidentiality requested by the
PCAOB, described its information systems and controls;
described its jurisdiction's laws and regulations that are
relevant to information access and (3) the PCAOB determines it
is appropriate to share such information. The information about
information controls and relevant law is to assist the PCAOB in
making an independent determination that the foreign authority
has the capability and authority to keep the information
confidential in its jurisdiction. The PCAOB may rely on
additional information in making the determination that the
information will be kept confidential and used no more
extensively than the same manner that the U.S. and State
entities identified in Section 105(b)(5)(B) of the Act may use
the information, which is an important consideration of
determining the appropriateness of such sharing.
Thus, the bill requires the Board to consider whether
applicable foreign laws and the respective foreign auditor
oversight authority offer protections comparable to those
provided under the Act. This would require the PCAOB to
consider not only the foreign auditor oversight authority's
willingness to maintain the confidentiality of the information,
but also its ability to do so, both as a matter of the law in
its jurisdiction and as a matter of the security of its
information technology systems. The Committee believes that the
Board could accept an assurance of confidentiality as adequate
even in circumstances where the foreign auditor oversight
authority could disclose the information to relevant law
enforcement or regulatory authorities in its jurisdiction, so
long as any such authorities are also committed and able to
comply with confidentiality limitations comparable to those
that apply to the U.S. and state entities with which the Board
shares information under Section 105(b)(5)(B) of the Act.
The Chairman of the PCAOB has written to the Chairman and
Ranking Member asking for legislation ``to allow the PCAOB to
share with a foreign audit oversight authority, upon receiving
appropriate assurances of confidentiality, the inspection and
investigative information related to the public accounting
firms within that authority's jurisdiction . . . [in order to]
facilitate the Board's and foreign authorities' efforts to
fulfill their inspection mandates. This recommendation enjoys
widespread investor and profession support.''\254\
---------------------------------------------------------------------------
\254\Letter from the Honorable Mark W. Olson, July 7, 2009.
---------------------------------------------------------------------------
Section 982. Oversight of brokers and dealers
Section 982 provides the Public Company Accounting
Oversight Board (``PCAOB'') with the authority to write
professional standards related to audits of SEC-registered
brokers and dealers, to inspect those audits, and, when
appropriate, to investigate and bring disciplinary proceedings
related to those audits. This Section provides the PCAOB with
authority over audits of registered brokers and dealers that is
generally comparable to its existing authority over audits of
issuers. This authority permits it to write standards for,
inspect, investigate, and bring disciplinary actions arising
out of, any audit of a registered broker or dealer. It enables
the PCAOB to use its inspection and disciplinary processes to
identify auditors that lack expertise or fail to exercise care
in broker and dealer audits, identify and address deficiencies
in their practices, and, where appropriate, suspend or bar them
from conducting such audits.
Currently, every SEC-registered broker and dealer is
required by section 17(e)(1)(A) of the Securities Exchange Act
of 1934 (15 U.S.C. 78q(e)(1)(A)) to file with the SEC a balance
sheet and income statement certified by a public accounting
firm that is registered with the PCAOB. However, the PCAOB's
authority to write professional standards, inspect audits,
investigate audit deficiencies, and bring disciplinary
proceedings for audit deficiencies extends to audits of
``issuers,'' as defined in section 2(a)(7) of the Sarbanes-
Oxley Act of 2002 (15 U.S.C. 7201(7)). Therefore, the PCAOB
does not have the authority to regulate and inspect audits of
brokers and dealers unless a broker or dealer is an issuer
(which is typically not the case) or its financial statements
are part of the consolidated financial statements of an issuer.
Under the current situation, where auditors of brokers and
dealers register with the PCAOB but their audits of brokers and
dealers are not subject to the PCAOB's standard setting,
inspection and disciplinary authority, investors may expect
that PCAOB-registered auditors of brokers and dealers are
subject to inspections and oversight when, in fact, the PCAOB
has no authority to govern the conduct or monitor the quality
of their audit work.
In a July 7, 2009 letter to Chairman Dodd and Ranking
Member Shelby, Chairman Mark Olson of the PCAOB recommended
that Congress consider amending the Sarbanes-Oxley Act to grant
the PCAOB authority to inspect audits of brokers and dealers
and to take action where deficiencies occur. The Securities
Investor Protection Corporation has supported granting the
PCAOB full oversight of audits of brokers and dealers, and
feels that the PCAOB's new oversight authority should apply to
audits of all registered brokers and dealers and not only those
that perform a clearing function or carry customer accounts.
The Section requires the PCAOB to allocate, assess and
collect its support fees among brokers and dealers as well as
issuers. The Committee expects that the PCAOB will reasonably
estimate the amounts required to fund the portions of its
programs devoted to the oversight of audits of brokers and
dealers, as contrasted to the oversight of audits of issuers,
in deciding the total amounts to be allocated to, assessed, and
collected from all brokers and dealers. The Committee notes
that the implementation of a program for PCAOB inspections of
auditors of brokers and dealers is not intended to and should
not affect the PCAOB's program for the inspections of auditors
of issuers. Cost accounting for each program is not required.
An example of the type of harm that might be avoided in the
future by extending PCAOB authority is the investor reliance on
the fraudulent audit of the broker-dealer Bernard L. Madoff
Investment Securities LLC by Friehling & Horowitz, a firm that
was not registered with the PCAOB.
Columbia University Law Professor John C. Coffee testified
before the Banking Committee on March 10, 2009: ``From this
perspective focused on prevention, rather than detection, the
most obvious lesson is that the SEC's recent strong tilt
towards deregulation contributed to, and enabled, the Madoff
fraud in two important respects. First, Bernard L. Madoff
Investment Securities LLC (``BMIS'') was audited by a fly-by-
night auditing firm with only one active accountant who had
neither registered with the Public Company Accounting Oversight
Board (``PCAOB'') nor even participated in New York State's
peer review program for auditors.''
Professor Coffee noted that the Sarbanes-Oxley Act
``required broker-dealers to use a PCAOB-registered auditor.
Nonetheless, until the Madoff scandal exploded, the SEC
repeatedly exempted privately held broker-dealers from the
obligation to use such a PCAOB-registered auditor and permitted
any accountant to suffice. Others also exploited this
exemption. For example, in the Bayou Hedge Fund fraud, which
was the last major Ponzi scheme before Madoff, the promoters
simply invented a fictitious auditing firm and forged
certifications in its name. Had auditors been required to have
been registered with PCAOB, this would not have been feasible
because careful investors would have been able to detect that
the fictitious firm was not registered . . . At the end of
2008, the SEC quietly closed the barn door by failing to renew
this exemption--but only after $50 billion worth of horses had
been stolen.''
Section 983. Portfolio margining
Section 983 amends the Securities Investor Protection Act
of 1970 (``SIPA''), which protects customers from certain
losses caused by the insolvency of their broker-dealer. Under
SIPA, claims of customers take priority over claims of general
unsecured creditors with respect to customer property held by
an insolvent broker-dealer. Under current law, the protections
of SIPA do not extend to futures contracts other than security
futures. As a result, customers currently are effectively
precluded from including securities and related futures in a
single securities account.
The Section will enable customers to benefit from hedging
activities by facilitating the inclusion of both securities and
related futures products in a single ``portfolio margining
account'' provided for under rules of self-regulatory
organizations approved by the Securities and Exchange
Commission (the ``SEC''). A portfolio margining account can be
margined based upon the net risk of the positions in the
account.
Section 983 is consistent with a recommendation of the SEC
and CFTC in their Joint Report on Harmonization of Regulation
released on October 16, 2009. The agencies recommended giving
customers the choice of whether to put related futures in a
securities account or their related securities derivatives in a
futures account. Customer choice is facilitated by extending
SIPC insurance to futures in a securities portfolio margining
account. The Section is also supported by each of the U.S.
exchanges that trade options.
Section 983 amends the definitions of ``customer,''
``customer property,'' and ``net equity'' in Section 16 of SIPA
to provide that the owner of a portfolio margining account
would be given the priority of a customer under SIPA with
respect to any futures contracts or options on futures
contracts permitted under SEC-approved rules to be carried in
the account. Similarly, the customer's ``net equity'' in the
account would include such futures and options on futures, and
they would be treated along with cash and securities in the
account as securities customer property. The definition of
``net equity'' is further amended to clarify that a customer's
claim for either a commodity futures contract or a security
futures contract will be treated as a claim for cash rather
than as a claim for a security. The Section also amends the
definition of ``gross revenues from the securities business''
to specifically include revenues earned by a broker or dealer
in connection with transactions in portfolio margining accounts
carried as securities accounts.
Section 984. Loan or borrowing of securities
During the period preceding the crisis, a number of
financial institutions used securities lending programs as a
basis for leveraged and risky trading activities. This Section
directs the SEC to write rules that are designed to increase
the transparency of information available to brokers, dealers,
and investors with respect to loaned or borrowed securities
within two years of the date of enactment of this Act. The
Section also makes it unlawful for any person to effect,
accept, or facilitate a transaction involving the loan or
borrowing of securities in contravention of such rules as the
SEC may prescribe. The SEC is encouraged to act in a shorter
period of time if necessary in the public interest.
Section 985. Technical corrections to federal securities laws
Section 986. Conforming amendments relating to the repeal of the Public
Utility Holding Company Act of 1935
Section 987. Amendment to definition of material loss and nonmaterial
losses to the Deposit Insurance Fund for purposes of Inspector
General reviews
Section 987 amends the definition of material loss and adds
``nonmaterial losses'' definition to the Deposit Insurance Fund
for purposes of Inspector General Reviews. The Inspectors
General (IG) of Federal Banking Regulators are required to
conduct a Material Loss Review for each depository institutions
that fails and costs the Deposit Insurance Fund $25 million and
more. The Senate Banking Committee has heard from the IGs that
due to the rise in bank failures they are severely strained by
the amount of Material Loss Reviews they must produce. In their
communications to the Banking Committee the IGs from Federal
Reserve, Treasury and FDIC have claimed to have hired more
personnel to reduce the backlog accumulated during the
financial crisis; however, the number of bank failures has also
been more than they've expected, and such, the volume of
workload has remained strenuously high. Because of this, and
the understanding that most of the bank failures seemed have
occurred due to similar reasons (exposure to failing mortgages)
the Committee is proposing an increase in the dollar amount
that the Deposit Insurance Fund must lose to trigger a Material
Loss Review. The change will follow this schedule: it will rise
from the current $25,000,000 to $100,000,000 for the period of
September 30, 2009 to December 31, 2010 and cascade down to
$75,000,000 for the period of January 1, 2011 to December 31,
2011, and rest on $50,000,000 for January 1, 2012 and after. In
bank failures that do not meet the materiality threshold (and
thus are ``nonmaterial losses'' to the Deposit Insurance Fund),
the IGs could still conduct a Material Loss Review if, based on
their preliminary assessment, such a report would be helpful.
For every 6 month period after March 31, 2010, the IGs must
prepare and submit a written report to the appropriate Federal
banking agency and to Congress on whether any losses deemed to
be nonmaterial exhibit unusual circumstances and deserve an in-
depth review of the loss.
Section 988. Amendment to definition of material loss and nonmaterial
losses to the National Credit Union Share Insurance Fund for
purposes of Inspector General reviews
Section 988 does for credit unions what Section 987 does
for other insured depository institutions. The Section defines
a material loss for the National Credit Union Share Insurance
Fund for purposes of Inspectors General reviews. If the Fund
incurs a material loss with respect to an insured credit union,
the Inspector General of the NCUA Board will submit to the
Board a written report reviewing the supervision of the credit
union by the Administration. For the purposes of this
provision, a material loss is defined as an amount exceeding
the sum of $25,000,000 or an amount equal to 10 percent of the
total assets of the credit union on the date on which the Board
initiated assistance. The GAO, under its discretion, could
review each of these reports and recommend improvements to the
supervision of insured credit unions.
For every 6 months period after March 31, 2010, the Board
IG must prepare and submit a written report to the appropriate
Federal banking agency and to Congress on whether any losses
deemed to be nonmaterial exhibit unusual circumstances and
deserve an in-depth review of the loss.
Section 989. Government Accountability Office study on proprietary
trading
Section 989A was authored by Senator Merkley. Section 989
directs the GAO to conduct a study on proprietary trading by
financial institutions and the implication of this practice on
systemic risk. This will include an evaluation of whether
proprietary trading presents a material systemic risk to the
stability of the United States financial system; whether
proprietary trading presents material risks to the safety and
soundness of the covered entities that engage in such
activities; whether proprietary trading presents material
conflicts of interest between covered entities that engage in
proprietary trading and the clients of the institutions who use
the firm to execute trades or who rely on the firm to manage
assets; whether adequate disclosure regarding the risks and
conflicts of proprietary trading is provided to the depositors,
trading and asset management clients, and investors of covered
entities that engage in proprietary trading; and whether the
banking, securities, and commodities regulators of institutions
that engage in proprietary trading have in place adequate
systems and controls to monitor and contain any risks and
conflicts of interest related to proprietary trading. The GAO
will submit a report to Congress on the results of this study
within 15 months of passage of the Act.
Section 989A. Senior investor protection
Section 989A was authored by Senator Kohl. Section 989A
defines the terms ``misleading designation'', ``financial
product'', ``misleading or fraudulent marketing'' and
``senior'' for the purposes of protecting senior citizens from
investment frauds. The Section directs the Office of Financial
Literacy within Bureau of Consumer Financial Protection to
establish a program to provide grants of up to $500,000 per
fiscal year to individual States to investigate and prosecute
misleading and fraudulent marketing practices or to develop
educational materials and training to reduce misleading and
fraudulent marketing of financial products toward seniors.
States may use the grants for staff, technology, equipment,
training and educational materials. To receive these grants,
states must adopt rules on the appropriate use of designations
in the offer or sale of securities or investment advice; on
fiduciary or suitability requirements in the sale of
securities; on the use of designations in the sale of insurance
products; and on insurer conduct related to the sale of annuity
products. This Section authorizes $8 million to be appropriated
for these purposes for fiscal years 2010 through 2014.
This section is intended to protect seniors from less than
scrupulous financial advisors who prey on the elderly by
touting misleading or fraudulent ``senior designations.'' Often
these deceptive designations can be obtained online and require
little or no training to acquire. The new grant program will
provide needed resources to state fraud enforcement agencies
fighting fraud. The grant application process will incentivize
states to crack down against the misleading use of senior
designations by encouraging them to adopt the North American
Securities Administrators Association (NASAA)'s and the
National Association of Insurance Commission's (NAIC) newly
developed model rules on the use of senior designations for the
sale of securities and insurance products. The grant also calls
for improved suitability standards for the sales of annuity
products, with provisions that are likely to be reflected in
the new suitability standards that are being developed by the
NAIC. This section has been endorsed by organizations such as
the AARP, North American Securities Administrators Association
(NASAA), National Organization for Competency Assurance (NOCA),
The American College, Financial Planners Association, Fund
Democracy, Consumer Federation of America, Alliance for Retired
Americans, National Association of Personal Financial Advisors
(NAPFA), Older Women's League (OWL) and Financial Certified
Planners Board of Standards (CFP Board).
Section 989B. Changes in appointment of certain Inspectors General
Senator Menendez authored this Section, which provides for
presidential appointment of the Inspectors General of the
Federal Reserve Board of Governors, the CFTC, the NCUA, the
PBGC, the SEC, and the Bureau of Consumer Financial Protection
with Senate approval. The provision is intended to increase the
stature of the Inspectors General within their agencies. This
Section strengthens also the subpoena authority.
Subtitle J
Section 991. Securities and Exchange Commission self-funding
Section 991 provides for the SEC to become a self-funded
organization. Each year the SEC will submit a budget request to
Congress and the Treasury. The Treasury will deposit this money
into an account for use by the SEC. The SEC will set its fees
and assessments at a level meant to fully repay Treasury. If
the SEC does not recoup sufficient funds, then the SEC is not
obligated to fully repay Treasury. Any collections in excess of
25% of the next year's budget request must be paid to Treasury.
The Council of Institutional Investors,\255\ former SEC
Chief Accountant Mr. Lynn Turner,\256\ the Investment Adviser
Association,\257\ and the Investor's Working Group\258\ support
this policy.
---------------------------------------------------------------------------
\255\Mr. Jeff Mahoney, Council of Institutional Investors, letter
to Senator Dodd, p.3, November 18, 2009.
\256\Enhancing Investor Protection and the Regulation of Securities
Markets--Part I: Testimony before the U.S. Senate Committee on Banking,
Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. Lynn Turner).
\257\Enhancing Investor Protection and the Regulation of Securities
Markets--Part II: Testimony before the U.S. Senate Committee on
Banking, Housing, and Urban Affairs, 111th Congress, 1st session (2009)
(Testimony of Mr. David Tittsworth).
\258\U.S. Financial Regulatory Reform: An Investor's Perspective,
Investor's Working Group, July 2009.
---------------------------------------------------------------------------
Title X--Bureau of Consumer Financial Protection
Section 1001. Short title
Section 1001 establishes the name of this title to be the
Consumer Financial Protection Act of 2010.
Section 1002. Definitions
Section 1002 provides the definitions for key terms in
Title X.
Paragraph 1 defines the term ``affiliate.''
Paragraph 2 explains that ``Bureau'' means the Bureau of
Consumer Financial Protection.
Paragraph 3 defines the term ``business of insurance.''
Paragraph 4 defines the term ``consumer.''
Paragraph 5 makes clear that financial products or services
defined in the Act that are offered or provided for use by
consumers primarily for personal, family, or household purposes
are considered to be ``consumer financial products or
services'' for purposes of this Act. The definition of
``consumer financial product or service'' in this paragraph is
a subset of the defined term ``financial product or serve'' in
paragraph 13, and includes all activities that are part of the
broader definition, which excludes the ``business of
insurance'' under paragraph 13(B). In addition, other key
financial activities that are central to consumers are also
included in this definition. These include, among others
listed, the servicing of mortgage loans and debt collection
services where the financial service being provided is the
result of a contract between the lender and the servicer or
debt collector. For example, mortgage servicers typically
provide services to the owners of the mortgages. Nonetheless,
this service is included in the definition of ``consumer
financial product or service'' because of its obvious impact on
consumers. A number of other financial activities of a similar
nature are included in this definition.
The Committee intends, however, that a financial
institution's exercise of bona fide trust or fiduciary powers
would not be subject to the jurisdiction of the Bureau. In
addition, financial products and services delivered for
establishing a trust, or to a trust itself, would not be for
use by a consumer primarily for personal, family, or household
purposes.
Paragraph 6 defines ``covered person'' as any person
engaged in offering or providing a consumer financial product
or service and an affiliate of such a person that provides a
material service in connection with the provision of such
consumer financial product or service is subject to the
regulatory authority of and, in some cases, to examinations by,
the CFPB under this title.
Paragraph 7 defines the term ``credit.''
Paragraph 8 defines ``deposit-taking activity.''
Paragraph 9 defines the term ``designated transfer date.''
Paragraph 10 defines the term ``Director.''
Paragraph 11 defines the term ``enumerated consumer laws.''
Paragraph 12 defines the term ``Federal consumer financial
law.''
Paragraph 13 defines the term ``financial product or
service'' and is modeled on the activities that are permissible
for a bank or a bank holding company, such as under section
4(k) of the Bank Holding Company Act and implementing
regulations. However, it is more narrowly drawn in this Act in
that the list does not include insurance or securities
activities. The paragraph describes the activities, products,
and services that are defined as a ``financial product or
service'' in the context of this legislation. The legislation
does not intend to capture as ``covered persons'' companies
that engage in financial data processing activities, as defined
in paragraph 13, where the company acts as a mere conduit for
such data, provides services to a person that enables that
person to establish and maintain a web site simply as a
conduit, or merchants that provide for electronic payments for
the sale of their nonfinancial goods or services.
Paragraph 14 defines the term ``foreign exchange.''
Paragraph 15 defines the term ``insured credit union.''
Paragraph 16 defines the term ``payment instrument.''
Paragraph 17 defines the term ``person.''
Paragraph 18 defines the term ``person regulated by the
Commodity Futures Trading Commission.''
Paragraph 19 defines the term ``person regulated by the
Commission.''
Paragraph 20 defines the term ``person regulated by a State
insurance regulator.''
Paragraph 21 defines the term ``person that performs income
tax preparation activities for consumers.''
Paragraph 22 defines the term ``prudential regulator.''
Paragraph 23 defines the term ``related person.''
Paragraph 24 defines the term ``service provider'' and is
designed to create authority that is generally comparable to
the authority that federal banking regulators have under the
Bank Service Company Act. It is included in this Act in order
to ensure that material outsourced services by a covered person
in connection with the offering or provision of a consumer
financial product or service are subject to the regulation and
supervision of the CFPB for the activities that could be done
directly by the covered person. Without such authority, covered
persons could remove many important functions that bear
directly on consumers from the CFPB's oversight simply by
contracting those functions out to service providers, thereby
escaping the jurisdiction of the CFPB and leading to
significant regulatory arbitrage. Companies that merely provide
general support or ministerial services to a broad range of
businesses, or space for advertising either in print or in an
electronic medium, are not intended to be defined as service
providers for the purposes of this Act.
Paragraph 25 defines the term ``State.''
Paragraph 26 defines the term ``stored value.''
Paragraph 27 defines the term ``transmitting or exchanging
money.'' This paragraph is not intended to capture a mere
conduit, such as a telecommunications company that provides a
network over which a money service business sends funds. The
paragraph is intended to cover the companies that are receiving
currency directly from a consumer, not as a consequence of
receiving it from the money service business for further
transmission to a recipient.
Subtitle A--Bureau of Consumer Financial Protection.
Section 1011. Establishment of the Bureau
This section creates the Bureau of Consumer Financial
Protection (the Bureau) in the Federal Reserve System; it
establishes the Bureau's authority to regulate the offering and
provision of consumer financial products and services. This
section also establishes the positions of the Director and
Deputy Director of the Bureau. The Director is appointed by the
President and confirmed by the Senate for a 5-year term and
subject to removal for cause.
Section 1012. Executive and administrative powers
Section 1012 authorizes the Bureau to establish general
policies with respect to all executive and administrative
functions of the Bureau. It provides that the Director may
delegate to any authorized employee, representative, or agent
any power vested in the Bureau. The section makes clear that
the Bureau is to operate without any interference by the Board
of Governors of the Federal Reserve including with regards to
rule writing, issuance of orders, examinations, enforcement
actions, and appointment or removal of employees of the Bureau.
These provisions are modeled on similar statutes governing the
Office of the Comptroller of the Currency and the Office of
Thrift Supervision, which are located within the Department of
Treasury.
This section also establishes that, like other federal
financial services regulators, any Bureau testimony,
legislative recommendations, or comments on legislation are not
subject to review or approval by other agencies. The Bureau
must make clear that any such communications do not reflect the
views of the President or Board of Governors.
Section 1013. Administration
This section authorizes the Director to appoint and employ
officials and professional staff, and to establish in the
Bureau functional units for research, community affairs, and
consumer complaints. The Committee expects these functions to
ensure that the Bureau has a robust knowledge of the markets
for consumer financial products and services in order to meet
its purposes and objectives in as efficient and effective
manner as possible. The Committee also expects the Bureau to
work with other federal agencies, such as the Federal Trade
Commission (FTC), to make use of the FTC's existing consumer
complaints collection infrastructure where efficient and
advantageous in facilitating complaint monitoring, response,
and referrals. Section 1013 also establishes within the Bureau
an Office of Fair Lending and Equal Opportunity and an Office
of Financial Literacy. Evidence of discriminatory pricing in
the provision of auto loans, certain terms of mortgage loans,
and other products indicate the importance of tracking this
information. Likewise, a more effective effort to improve
financial literacy should play a crucial role in improving
consumer protection.
Section 1014. Consumer Advisory Board
Section 1014 requires the Director to create a Consumer
Advisory Board and to consult with it on matters pertaining to
the Bureau's functions and authorities. This panel is modeled
on the Consumer Advisory Council of the Federal Reserve Board
and is intended to bring a broad spectrum of perspectives
together to advise the Director. This provision requires the
Director to appoint 6 members to the Consumer Advisory Board
who have been recommended by the Federal Reserve Bank
Presidents. The provision requires that members are appointed
without regard to party affiliation, just like the members of
the advisory committees to the Federal Reserve, the SEC, the
FDIC, the FDA, and many other federal advisory committees. This
is important because, as the GAO found in 2004, when a federal
advisory committee is viewed as politicized, the value of its
work can be jeopardized.
Section 1015. Coordination
This section requires the Bureau to coordinate with the SEC
and CFTC and Federal agencies and State regulators to promote
consistent regulatory treatment of consumer financial and
investment products and services.
Section 1016. Appearances before and reports to Congress
This section requires the Director to appear before
Congress at semi-annual hearings and, concurrently, to prepare
and submit a report to the President and Congress concerning
the Bureau's budget and regulation, supervision, and
enforcement activities. This provision is modeled on the semi-
annual monetary report and testimony requirement imposed on the
Federal Reserve. The Committee expects that this requirement
will ensure the ongoing accountability of the Bureau to the
Committee and the Congress.
Section 1017. Funding; penalties and fines
Section 1017 requires the Federal Reserve Board to transfer
the amount determined by the Director to to be reasonably
necessary for the Bureau's annual budget, not to exceed a
specified percentage of the total operating expenses of the
Federal Reserve System as reported in the 2009 Annual Report of
the Board of Governors. The Bureau's funding is capped at 12
percent for fiscal year 2013 and each year thereafter, except
that the cap is to be adjusted for inflation, and will be
subject to annual audits and reports to Congress by the GAO.
This funding is needed to perform the following key functions:
examinations and enforcement over larger banks, mortgage market
companies, and other large covered nondepository companies;
registration and reporting by nondepository companies that are
subject to the Bureau's examination authority; analytical
support, monitoring and research, industry guidance and
rulemaking; operation of a nationwide consumer complaint
center; and consumer financial education. The mortgage market
consists of more than 25,000 lenders, servicers, brokers, and
loan modification firms that would be subject to Bureau
supervision and enforcement. The Treasury estimates that there
are more than 75,000 nonbank, non-mortgage firms offering or
providing consumer financial products or services, of which the
agency would supervise a percentage. In order to conduct
thorough supervision of these firms comparable to bank consumer
compliance supervision will require an adequate budget.
The Committee finds that the assurance of adequate funding,
independent of the Congressional appropriations process, is
absolutely essential to the independent operations of any
financial regulator. This was a hard learned lesson from the
difficulties faced by the Office of Federal Housing Enterprise
Oversight (OFHEO), which was subject to repeated Congressional
pressure because it was forced to go through the annual
appropriations process. It is widely acknowledged that this
helped limit OFHEO's effectiveness. For that reason, ensuring
that OFHEO's successor agency--the Federal Housing Finance
Agency--would not be subject to appropriations was a high
priority for the Committee and the Congress in the Housing and
Economic Recovery Act of 2008. The budget established in this
Act will ensure that the Bureau has the funds to perform its
mission. By comparison with other financial regulatory bodies,
the CFPB budget is modest, as the chart below illustrates.
This section also establishes within the Federal Reserve
Board a special fund for receipts which can be invested under
certain guidelines and which are to be used to pay for Bureau
expenses. Finally, section 1017 creates a victims' relief fund
for civil penalties obtained by the Bureau.
Section 1018. Effective date
This section provides that this subtitle shall become
effective on the date of enactment of this Act.
Subtitle B--General Powers of the Bureau
Section 1021. Purpose, objectives, and functions
This section mandates that the purpose of the Bureau is to
implement and enforce, where applicable, Federal consumer
financial laws to ensure that markets for consumer financial
products and services are fair, transparent and competitive.
The Bureau is authorized to act to ensure that consumers
are provided with accurate, timely, and understandable
information in order to make effective decisions about
financial transactions; to protect consumers from unfair,
deceptive, or abusive acts and practices and from
discrimination; to reduce unwarranted regulatory burdens; to
ensure that Federal consumer financial law is enforced
consistently in order to promote fair competition; and to
ensure that markets for consumer financial products and
services operate transparently and efficiently to facilitate
access and innovation.
This section further establishes the Bureau's functions
with regard to regulation, supervision and enforcement,
including: conducting financial education programs; collecting,
investigating and responding to consumer complaints; collecting
and publishing information relevant to the functioning of
markets for consumer financial products and services;
supervising covered persons for compliance with Federal
consumer financial law, and taking appropriate enforcement
action; issuing rules, orders and guidance; and performing
other necessary support activities to facilitate the Bureau's
functions.
Section 1022. Rulemaking authorities
This section authorizes the Bureau to administer, enforce
and implement the provisions of Federal consumer financial law
and, more specifically, authorizes the Bureau to prescribe
rules and issue orders and guidance as may be necessary to
carry out the purposes, and prevent evasions of, those laws.
Under this section, the Bureau must, when prescribing rules,
consider potential benefits and costs to consumers and covered
persons, and consult with prudential regulators regarding
consistency with safety and soundness considerations and other
objectives of such agencies. This consultation would have to
take place prior to the Bureau proposing a rule as well as
during the public comment process. If during such consultation
process a prudential regulator provides the Bureau with a
written objection to the proposed rule, the Bureau is required
to include in the adopting release a description of the
objection and the basis for the Bureau's decision regarding
such objection. The Bureau is authorized under this section to
exempt classes of covered persons, service providers, or
consumer financial products or services, from provisions of
this title.
This section requires the Bureau to monitor for risks to
consumers in the offering or provision of consumer financial
products or services. In monitoring for risks, the Bureau is
authorized to consider factors including likely risks and costs
to consumers associated with buying or using a type of consumer
financial product or service, the extent to which the law is
likely to adequately protect consumers, and the extent to which
the risks of a consumer financial product or service may
disproportionately affect traditionally underserved consumers.
The Bureau is further granted authority to gather and compile
information regarding the organization, business conduct,
markets, and activities of persons operating in consumer
financial services markets, and to make such information
public, as is in the public interest.
The Committee considers the monitoring and information
gathering function to be an essential part of the Bureau's
work. The Bureau must stay closely attuned to the marketplace
for consumer financial products and services in order to
effectively fulfill the purposes and objectives of this title.
Under this section, the Bureau is provided with access to
the examination and financial condition reports made by a
prudential regulator or other Federal agency having
jurisdiction over a covered person. Similarly, a prudential
regulator, State regulator or other Federal agency having
jurisdiction over a covered person is provided with access to
any examination reports made by the Bureau. The Bureau is
required to take steps to ensure that proprietary, personal or
confidential information is protected from public disclosure.
In addition, the Bureau is required to assess the efficacy of
its rules.
Section 1023. Review of Bureau regulations
This section provides for a process by which the Financial
Stability Oversight Council may set aside a final regulation
promulgated by the Bureau if, in the view of two-thirds of the
Council, the regulation would put the safety and soundness of
the banking system or the stability of the financial system at
risk. Under this section, an agency represented by a member of
the Council may petition the Council to stay the effectiveness
of, or set aside, a regulation if the member agency filing the
petition has attempted to work with the Bureau to resolve
concerns regarding the effect of the rule on financial
stability or safety and soundness of the banking system. Such
petition is required to be filed with the Council not later
than 10 days after the regulation has been published in the
Federal Register. A decision by the Council to set aside a
regulation prescribed by the Bureau shall render such
regulation unenforceable.
Any such decision by the Council would be required to be
done within certain specified time limits. A decision to issue
a stay of, or set aside, a regulation is required to be
published in the Federal Register as soon as practicable after
the decision is made, with an explanation of the reasons for
the decision. A decision by the Council to set aside a
regulation prescribed by the Bureau is subject to judicial
review.
This provision is designed to ensure that consumer
protection regulations do not put the safety and soundness of
the banking system or the stability of the financial system at
risk. This provision is in addition to the significant
consultation requirements included in Section 1022.
The Committee notes that there was no evidence provided
during its hearings that consumer protection regulation would
put safety and soundness at risk. To the contrary, there has
been significant evidence and extensive testimony that the
opposite was the case. Specifically, it was the failure by the
prudential regulators to give sufficient consideration to
consumer protection that helped bring the financial system
down. In fact, it was the organizations that promote consumer
protection that were urging that underwriting standards be
tightened for both consumer protection and safety and soundness
reasons, and it was the prudential regulators who ignored these
calls.
For example, in testimony before the Committee (June 26,
2007), David Berenbaum from the National Community Reinvestment
Coalition said, ``For the past 5 years, community groups,
consumer protection groups, fair lending groups, and all of our
members in the National Community Reinvestment Coalition have
been sounding an alarm about poor underwriting--underwriting
that not only endangered communities, their tax bases, their
municipal governments, their ability to have sound services and
celebrate homeownership--but [underwriting that] was going to
impact on the safety and soundness of our banking institutions
themselves. Those cries for action fell on deaf ears, and here
we are today.''
An article in the American Banker (``Do Safety and
Soundness and Consumer Protection Really Conflict?,'' by
Cheyenne Hopkins, March 30, 2010) calls the banking industry
argument that such a conflict exists ``shaky.'' The article
quotes Kevin Jacques who worked for 10 years in the Office of
the Comptroller of the Currency, who said, ``. . . I cannot
recall a meeting I sat in where we worried about consumer
protection and looked at safety and soundness and said the two
are in conflict. . . .'' A former New York Federal Reserve Bank
official, Brad Sabel, agreed with this assessment, saying ``In
my experience I do not recall seeing a case where a consumer
protection regulation was found to pose a threat to safe and
sound operations of the banks.''
Nonetheless, the Committee included this provision in order
to reassure that the Bureau cannot put the safety and soundness
or the stability of the financial system at risk.
Section 1024. Supervision of nondepository covered persons
Section 1024 establishes the scope of the Bureau's
supervisory authority over certain nondepository institutions
(nondepository covered persons). Oversight of these companies
has largely been left to the States, and they are not currently
subject to regular Federal consumer compliance examinations
comparable to examinations of their depository institution
competitors. According to one Treasury official, ``The federal
government spends at least 15 times more on consumer compliance
and enforcement for banks and credit unions than for nonbanks--
even though there are at least five times as many nonbanks as
there are banks and credit unions.'' The Federal Trade
Commission has approximately 70 staff members assigned to
perform enforcement and monitoring functions for approximately
100,000 nondepository financial service providers nationwide.
The FTC's authority to issue rules regarding unfair and
deceptive practices is constrained by procedural requirements,
and it does not have authority to conduct compliance exams, as
bank regulators do. For that reason, it has brought fewer than
25 lawsuits in the last five years against mortgage
originators, payday lenders and debt collectors.
The authority provided to the Bureau in this section will
establish for the first time consistent Federal oversight of
nondepository institutions, based on the Bureau's assessment of
the risks posed to consumers and other criteria set forth in
this section. Banks and other nondepository companies that
provide consumer financial products or services should be held
to the same minimum standards for complying with Federal
consumer financial laws regardless of their corporate
structure. Specifically, the Bureau will have the authority to
supervise all participants in the consumer mortgage arena,
including mortgage originators, brokers, and servicers and
consumer mortgage modification and foreclosure relief services.
These entities contributed to the housing crisis that led to
the near collapse of the financial system. The Bureau will also
have the authority to supervise larger nondepository
institutions that offer or provide other consumer financial
products and services. Larger nondepositories will be defined
through a Bureau rulemaking and in consultation with the
Federal Trade Commission. Nondepository covered persons that
are subject to the Bureau's supervision authority will be
required to register with the Bureau. This section does not
apply to depository institutions.
Specifically, the Bureau will have the authority to
supervise all participants in the consumer mortgage arena,
including mortgage originators, brokers, and servicers and
consumer mortgage modification and foreclosure relief services.
These entities contributed to the housing crisis that led to
the near collapse of the financial system. The Bureau will also
have the authority to supervise larger nondepository
institutions that offer or provide other consumer financial
products and services. Larger nondepositories will be defined
through a Bureau rule making and in consultation with the
Federal Trade Commission. Nondepository covered persons that
are subject to the Bureau's supervision authority will be
required to register with the Bureau. This section does not
apply to depository institutions.
The Bureau will have the authority to require reports from
and to conduct periodic examinations of nondepository covered
persons described in section 1026(a) to assess compliance with
Federal consumer financial laws, to obtain information about
activities and compliance systems, and to detect and assess
risks to consumers and markets for consumer financial products
and services. The Bureau will exercise its authority by
establishing a risk-based supervision program based on an
assessment of the risks posed to consumers in certain product
and geographic markets. In establishing the risk-based
supervisory program, the Bureau will consider the asset size of
the nondepository covered person, the volume of consumer
financial product and service transactions it is engaged in,
the risks to consumers of those products and services, and the
extent to which the institution is overseen by State
regulators.
Section 1024 provides that the Bureau's enforcement
authority over larger nondepository covered persons, other than
mortgage entities described in section 1024(a)(1)(A), is
exclusive, although other Federal agencies may recommend (in
writing) enforcement actions to the Bureau. Pursuant to a
Memorandum of Understanding, the Bureau and the FTC will
coordinate enforcement action of nondepository mortgage actors,
including civil actions.
Section 1025. Supervision of very large banks, savings associations,
and credit unions
Section 1025 grants the Bureau primary examination and
enforcement authority over all insured depository institutions
and credit unions with more than $10 billion in assets. This
authority extends to the affiliates and service providers of
these large depositories. The current consumer protection
system divides jurisdiction and authority for consumer
protection between many federal regulators, whose mission is
not focused on consumer protection. The result has been that
banks could choose the least restrictive consumer compliance
supervisor. The fragmented regulatory structure also resulted
in finger pointing among regulators and inaction when problems
with consumer products and services arose. The authority
granted to the Bureau under this section creates one federal
regulator with consolidated consumer protection authority over
the largest depository institutions, leaving regulatory
arbitrage and inter-agency finger pointing in the past.
Specifically, the Bureau will have the authority to require
reports from and to conduct periodic examinations of the
largest depository institutions to assess compliance with
Federal consumer financial laws, to obtain information about
activities and compliance systems, and to detect and assess
risks to consumers and markets for consumer financial products
and services. In order to minimize regulatory burden, the
Bureau is required to coordinate examination and enforcement
activities with the appropriate prudential regulator, including
coordinating the scheduling of examinations, conducting
simultaneous examinations unless the financial institution
requests otherwise, sharing draft reports, requiring reasonable
opportunity (30 days) to comment, and requiring that concerns
raised by the prudential regulator be considered prior to
issuing a final report. The Bureau must also pursue
arrangements and agreements with State bank supervisors to
coordinate examinations where appropriate.
Section 1025 also provides that any conflicts between
regulators may be resolved by a governing panel. If the
proposed supervisory determinations of the Bureau and the
prudential regulator conflict, the examined financial
institution may request that the agencies coordinate and
present a joint statement of coordinated supervisory action.
The agencies have 30 days to comply. If the agencies do not
issue a joint statement, the financial institution may appeal
to a governing panel 30 days after the joint statement is due.
The governing panel would consist of a representative of the
Board of Governors, the FDIC, the NCUA or OCC on a rotating
basis (as long as that agency is not involved in the dispute)
and a representative of the Bureau and the prudential
regulator. The panel would have 30 days to provide a final
determination to the financial institution.
Section 1026. Other banks, savings associations, and credit unions
Section 1026 provides that an insured depository
institution or credit union with $10 billion in assets or less
will continue to be examined for consumer compliance by its
prudential regulator. The Bureau is authorized to ride along on
a sample of examinations conducted by the prudential
regulators, which will assist the Bureau in understanding the
operations of smaller banks and credit unions. The Bureau would
not have authority to take enforcement action. Section 1026
provides the Bureau access to reports by banks and credit
unions under the $10 billion threshold to help it better
understand the markets for consumer financial products and
services, and to ensure that it is a fair and consistent
market-wide rule writer.
Section 1027. Limitations on authorities of the Bureau; preservation of
authorities
Section 1027 lays out the limits on the Bureau's authority
with regard to certain entities and product types. These
limitations make clear that the Bureau does not have authority
over commercial transactions or the sale of nonfinancial goods
or services.
Subsection (a) makes clear that the Bureau may not exercise
any authority with respect to a merchant, retailer, seller or
broker of nonfinancial good or service. However, the Bureau
would have authority if such a person is significantly engaged
in offering or providing any consumer financial product or
service or is otherwise subject to an enumerated consumer law
or other law that is transferred to the Bureau's authority.
This subsection also allows a merchant to extend credit to a
consumer for the purchase of a nonfinancial good or service
without coming under the authority of the Bureau under this
title. This has been described as allowing local merchants to
``extend a tab'' to a customer. Merchants may also collect
these debts (or hire someone to do so), or sell such debts, if
delinquent, without being subject to the Bureau's authority
over those activities. This limitation would not extend to
merchants who, for example, extend credit which exceeds the
market value of the good or service offered or provided or who
regularly extend credit that is subject to a finance charge and
payable by written agreement in more than 4 installments.
Under this subsection, the Bureau would have no authority
to issue rules or take enforcement action against merchants,
retailers, or sellers of nonfinancial goods or services that
are not engaged significantly in offering or providing consumer
financial products or services. This makes clear that the
Committee intends to exclude persons and businesses such as
dentists, doctors, and small Main Street retailers that simply
allow their customers to pay bills over time from the new
authority of the Bureau. Such persons typically are not engaged
significantly in offering or providing consumer financial
products or services.
Finally, for the purposes of this section (a), the term
``finance charge'' is expected to be interpreted consistent
with the current rules that implement the Truth in Lending Act,
including appropriate exclusions from that term for charges for
unanticipated late payment, delinquency, or default.
Subsection (b) clarifies that real estate brokerage
activities are not covered by the Bureau except to the extent
that a real estate broker is engaged in the offering of a
consumer financial product or service or is otherwise subject
to an enumerated consumer law or transferred authority.
Subsection (c) clarifies that retailers of manufactured
housing and modular homes are not covered by the Bureau, except
to the extent that a retailer is engaged in offering or
providing a consumer financial product or service or is
otherwise covered by a Federal consumer financial law.
Subsection (d) clarifies that accountants and tax preparers
are not covered by the Bureau for certain activities.
Subsection (e) clarifies that attorneys are not covered by
the Bureau to the extent they are engaged in the practice of
law under the law of the State in which they are licensed.
However, this exception to the Bureau's coverage does not
extend to an attorney who is engaged in the offering of a
consumer financial product or service or is otherwise subject
to an enumerated consumer law or transferred authority.
Subsection (f) clarifies that persons regulated by a State
insurance regulator are not covered by the Bureau except to the
extent that such persons are engaged in the offering of a
consumer financial product or service or are otherwise covered
by a Federal consumer financial law.
Subsection (g) clarifies the authority of the Bureau with
regards to employee benefit plans and certain other
arrangements under the Internal Revenue Code of 1986, such as
IRAs, certain education savings accounts, and others. The
subsection preserves the authority of other existing agencies
that regulate these programs. The subsection also prohibits the
Bureau from exercising any authority with respect to these
plans except in very limited circumstances. Any rulemaking
could be done only after a joint request by the Secretary of
Labor and the Secretary of the Treasury.
Subsection (h) clarifies that persons regulated by a State
securities commission are not covered by the Bureau except to
the extent that such persons are engaged in the offering of a
consumer financial product or service or are otherwise subject
to an enumerated consumer law or transferred authority.
Subsection (i) clarifies that persons regulated by the SEC
are not covered by the Bureau. However, the SEC is required to
consult and coordinate with the Bureau with respect to any rule
for the same type of product as, or competes directly with, a
consumer financial product or service that is subject to the
Bureau's jurisdiction. This is to ensure equivalent regulatory
treatment and prevent regulatory arbitrage.
Subsection (j) clarifies that persons regulated by the CFTC
are not covered by the Bureau. As in subsection (i),
coordination and consultation are required for rule making
regarding products of the same type or that compete with each
other and fall under the Bureau's jurisdiction.
Subsection (k) clarifies that the Bureau has no authority
with respect to a person regulated by the Farm Credit
Administration.
Subsection (l) clarifies that activities relating to
charitable contributions are not covered by the Bureau.
However, activities not involving charitable contributions that
are the offering or provision of any consumer financial product
or service are covered.
Subsection (m) clarifies that the Bureau may not define
engaging in the business of insurance as a financial product or
service.
Subsection (n) clarifies that a number of persons that are
described above may be a service provider and subject to
certain requests for information.
Subsection (o) clarifies that nothing in this title shall
be construed as conferring authority on the Bureau to establish
a usury limit on an extension of credit or made by a covered
person to a consumer unless explicitly authorized by law.
Subsection (p) preserves the authorities of the Attorney
General of the United States.
Subsection (q) preserves the authorities of the Secretary
of the Treasury with regards to a person who performs income
tax preparation activities for consumers.
Subsection (r) preserves the authority of the FDIC and NCUA
with regards to deposit and share insurance.
Section 1028. Authority to restrict mandatory pre-dispute arbitration
The Committee is concerned that consumers have little
leverage to bargain over arbitration procedures when they sign
a contract for a consumer financial product or service. The
Bureau is therefore required by this section to conduct a study
and provide a report to Congress on the use of mandatory pre-
dispute arbitration agreements as they pertain to the offering
or provision of consumer financial products or services. This
section grants the Bureau authority to prohibit or impose
conditions and limitations on certain arbitration agreements
between a covered person and a consumer consistent with the
results of the study if it is in the public interest.
Additionally, the Bureau is prohibited from restricting
consumers from entering into voluntary arbitration agreements
after a dispute has arisen.
The bill empowers the Bureau to take a range of steps,
which could include a prohibition, or could instead be to
impose conditions or limitations. In addition, the Bureau may
choose to focus on pre-dispute mandatory arbitration provisions
in contracts for certain types of consumer financial products
or services, such as mortgage loans. The Bureau has to justify
any rule by finding it is in the public interest and for the
protection of consumers.
Section 1029. Effective date
This section provides that this subtitle become effective
on the designated transfer date.
Subtitle C--Specific Bureau Authorities
Section 1031. Prohibiting unfair, deceptive, or abusive acts or
practices
This section authorizes the Bureau to prevent a covered
person from engaging in or committing an unfair, deceptive or
abusive act or practice in connection with a transaction with a
consumer for a consumer financial product or service, or the
offering thereof. The Bureau is authorized to prescribe rules
to identify such acts or practices. In prescribing rules, the
Bureau is required to consult with the Federal banking
agencies, or other Federal agencies, as appropriate, concerning
the consistency of the proposed rule with prudential, market,
or systemic objectives administered by such agencies.
Current law prohibits unfair or deceptive acts or
practices. The addition of ``abusive'' will ensure that the
Bureau is empowered to cover practices where providers
unreasonably take advantage of consumers. The Bureau could
define acts or practices as abusive only if it has a factual
basis to show that the act or practice either: (1) materially
interferes with the ability of a consumer to understand a term
or condition of a consumer financial product or service; or (2)
takes unreasonable advantage of consumers' lack of
understanding of material risks, costs, or conditions of the
product, inability to protect their interests in selecting or
using the product, or reasonable reliance on a covered person
to act in the consumers' interest.
Section 1032. Disclosures
This section helps ensure that consumers receive effective
disclosures relevant to the purchase of consumer financial
products or services. Under this section, the Bureau is granted
rulemaking authority to ensure that information relevant to the
purchase of such products or services is disclosed to the
consumer in plain language in a manner that permits consumers
to understand the costs, benefits, and risks associated with
the product or service. In prescribing rules, the Bureau is
required to consider available evidence about consumer
awareness, understanding of, and responses to disclosures or
communications about the risks, costs, and benefits of consumer
financial products or services. The Bureau is granted the
authority to provide a model form of such disclosure standards,
and a safe harbor is provided for covered persons that use
model forms included with a rule issued under this section.
Under this section, a procedure is established to allow the
Bureau to permit a covered person to conduct a trial disclosure
program for the purpose of improving on any model disclosure
forms issued to consumers to implement an enumerated consumer
law. The Bureau is required to propose for public comment rules
and model forms that combine Truth in Lending Act (TILA) and
Real Estate Settlement Procedures Act (RESPA) disclosures.
Section 1033. Consumer rights to access information
This section ensures that consumers are provided with
access to their own financial information. This section
requires the Bureau to prescribe rules requiring a covered
person to make available to consumers information concerning
their purchase and possession of a consumer financial product
or service, including costs, charges, and usage data. The
information is required to be made available upon a consumer's
request in an electronic form usable by the consumer.
Under this section, a covered person may not be required to
make available any confidential or proprietary information, any
information collected by the covered person for antifraud or
anti-money laundering purposes, or any information that the
covered person cannot retrieve in the ordinary course of
business. This section does not impose a duty on covered
persons to maintain or keep any information about a consumer.
Section 1034. Response to consumer complaints and inquiries
Section 1034 requires the Bureau to establish procedures,
in consultation with the appropriate Federal regulatory
agencies, for providing a timely response to consumer
complaints or inquiries which include steps taken by the
regulator in response to the complaint or inquiry, any
responses received by the regulator from the institution, and
any follow-up plans or actions by the regulator in response to
the consumer complaint or inquiry.
In addition, this section requires very large banks and
credit unions (as defined in section 1025) subject to
supervision and primary enforcement by the Bureau to provide a
timely response to the Bureau, the prudential regulators, and
any other related agency concerning a consumer complaint or
inquiry. This includes steps taken by the institution in
response to the complaint or inquiry, responses received by the
institution from the consumer, and any follow-up plans or
actions by the institution in response to the consumer
complaint or inquiry.
Section 1034 also requires these very large depository
institutions to comply in a timely manner with a consumer
request for information in the control or possession of the
institution concerning the account of the consumer, not
including any confidential commercial information, such as
algorithms used to derive credit scores, information collected
for the purpose of preventing fraud or other unlawful or
potentially unlawful conduct, information required to be kept
confidential by any other provision of law, or any nonpublic or
confidential information, including confidential supervisory
information.
Finally, this section requires the Bureau to enter into a
Memorandum of Understanding with the appropriate Federal
regulatory agencies to establish procedures by which very large
depository institutions and relevant agencies shall comply with
this section.
Section 1035. Private Education Loan Ombudsman
Section 1035 requires the Secretary of the Treasury, in
consultation with the Director, to designate a Private
Education Loan Ombudsman within the Bureau to provide timely
assistance to borrowers of private education loans, and to
disseminate information about the availability and functions of
the Ombudsman to borrowers, potential borrowers, and related
institutions, agencies, and participants.
This section requires the Ombudsman to receive, review, and
attempt to informally resolve complaints from borrowers of
private student loans. It also ensures coordination with the
student loan ombudsman established under the Higher Education
Act of 1965 by requiring a Memorandum of Understanding no later
than 90 days after the designated transfer date. The Private
Education Loan Ombudsman will also compile and analyze data on
borrower complaints regarding private education loans, and make
recommendations to the Director, the Secretary of Treasury, the
Secretary of Education, and relevant Congressional Committees.
Finally, the Ombudsman is required to prepare an annual
report describing and evaluating its activities during the
preceding year, and to submit the report on a consistent annual
date to the Secretary of the Treasury, the Secretary of
Education, and relevant Congressional Committees.
Section 1036. Prohibited acts
This section prohibits by law certain activities such as
the selling or advertising of consumer financial products or
services which are not in conformity with the sections of this
title, the failure or refusal to provide information to the
Bureau as required by law, and knowingly or recklessly
providing substantial assistance to another person in violation
of section 1031.
Section 1037. Effective date
This section provides that this subtitle become effective
on the designated transfer date.
Subtitle D--Preservation of State Law
Section 1041. Relation to State law
Section 1041 confirms that the Consumer Financial
Protection Act (CFP Act) will not preempt State law if the
State law provides greater protection for consumers. Federal
consumer financial laws have historically established only
minimum standards and have not precluded the States from
enacting more protective standards. This title maintains that
status quo.
A strong and independent Bureau with a clear mission to
keep consumer protections up-to-date with the changing
marketplace will reduce the incentive for State action and
increase uniformity. The Gramm-Leach-Bliley Act of 1999 set
federal financial privacy standards and gave the States the
authority to go further. Only three States have used that
power, and banks' operations have not been impaired. If States
can continue to provide new consumer protections as problems
arise, and the Bureau has the authority to follow the market
and keep Federal protection up-to-date, then the Bureau will be
in a position to set a strong, consistent standard that will
satisfy the States.
Additionally, State initiatives can be an important signal
to Congress and Federal regulators of the need for Federal
action. States are much closer to abuses and are able to move
more quickly when necessary to address them. If States were not
allowed to take the initiative to enact laws providing greater
protection for consumers, the Federal Government would lose an
important source of information and reason to adjust standards
over time.
For that reason, section 1041 also requires the Bureau to
propose a rule making when a majority of the States has enacted
a resolution requesting a new or modified consumer protection
regulation by the Bureau. As part of the rule making, the
Bureau is required to consult with federal banking agencies to
determine whether the proposed regulation presents an
unacceptable safety and soundness risk. The Bureau must also
make public in the Federal Register its determination to act or
not to act on the States' request.
Section 1042. Preservation of enforcement powers of States
Section 1042 grants authority to State attorneys general to
enforce this Act against Federal and State chartered entities.
State regulators are also authorized to take appropriate action
against State chartered entities. The section also clarifies
that the CFP Act does not limit any provision of any enumerated
consumer law that relates to State authority to enforce Federal
law. State attorneys general and regulators are directed to
consult or notify the Bureau and the prudential regulators,
when practicable, before initiating an enforcement action
pursuant to this section. This section also confirms that the
CFP Act has no impact on the authority of State securities or
State insurance regulators regarding their enforcement actions
or rulemaking activities.
Section 1043. Preservation of existing contracts
Section 1043 makes clear that the CFP Act shall not be
construed to affect the applicability of any rule, order,
guidance or interpretation by the OCC or OTS regarding the
preemption of State law by a Federal banking law to any
contract entered into by banks, thrifts, or affiliates and
subsidiaries thereof, prior to the date of enactment of the CFP
Act. This section is intended to provide stability to existing
contracts.
Section 1044. State law preemption standards for national banks and
subsidiaries clarified
Section 1044 amends the National Bank Act to clarify the
preemption standard relating to State consumer financial laws
as applied to national banks. This section does not alter the
preemption standards for State laws of general applicability to
business conduct. State consumer financial laws are defined as
laws that directly and specifically regulate the manner,
content, or terms and conditions of financial transactions or
accounts with respect to consumers. The standard for preempting
State consumer financial law would return to what it had been
for decades, those recognized by the Supreme Court in Barnett
Bank v. Nelson, 517 U.S. 25 (1996 Barnett), undoing broader
standards adopted by rules, orders, and interpretations issued
by the OCC in 2004.
Specifically, this section sets out the three circumstances
under which a State consumer financial law can be preempted:
(1) when the State law would have a discriminatory effect on
national banks or federal thrifts in comparison with the effect
of the law on a bank or thrift chartered in that State; (2) if
the State law, as described in the standard established by the
Supreme Court in Barnett, ``prevents or significantly
interferes with a national bank's exercise of its power;'' or
(3) the State law is preempted by another Federal law. A
preemption determination pursuant to Barnett can be made by
either a court or by the OCC on a case-by-case basis. The term
``case-by-case basis'' is defined to permit the OCC to make a
single determination concerning multiple States' consumer
financial laws, so long as the law contains substantively
equivalent terms.
Prior to making a determination under the Barnett standard,
the OCC must follow certain procedures when making a preemption
determination. Prior to making such a determination the OCC
must first consult with, and consider the views of, the Bureau.
The determination by the OCC must also be based on substantial
evidence supporting the finding that the provision meets the
Barnett standard. After consulting with the Bureau, the OCC
must make a written finding that a federal law provides a
relevant substantive standard that would protect consumers if
the State law was to be preempted. The federal standard does
not have to be as strong as the State law that is being
preempted.
Section 1044 clarifies that nothing affects the deference
that a court may afford to the OCC under the Chevron doctrine
when interpreting Federal laws administered by that agency,
except for preemption determinations. For a preemption
determination, a reviewing court must assess the validity of
the agency's preemption claim based on certain factors, as the
court finds to be persuasive and relevant.
Section 1044 does not alter or affect existing laws
regarding the charging of interest by national banks
Finally, the OCC is required to periodically publish a list
of its preemption determinations.
Section 1045. Clarification of law applicable to nondepository
institutions subsidiaries
Section 1045 clarifies that State law applies to State-
chartered nondepository institution subsidiaries, affiliates,
and agents of national banks, other than entities that are
themselves chartered as national banks. Such entities are
generally chartered by the States and therefore should be
subject to State law.
Section 1046. State law preemption standards for federal savings
associations and subsidiaries clarified
Section 1046 amends the Home Owners' Loan Act to clarify
that State law preemption standards for Federal savings
associations and their subsidiaries shall be made in accordance
with the standard applicable to national banks.
Section 1047. Visitorial standards for national banks and savings
associations
Section 1047 clarifies that a State attorney general may
bring a judicial action against a national bank or Federal
savings association to enforce Federal law, as permitted by
such law, or nonpreempted State law, which is consistent with
the provisions of the National Bank Act and Home Owners' Loan
Act relating to visitorial powers. The United States Supreme
Court affirmed this when it overturned a Federal preemption of
States to enforce valid State laws against national banks in
Cuomo v. Clearing House Association, 557 U.S. (2009) (Cuomo).
The Court held that the National Bank Act generally preempts
``vistorial'' supervisory powers by States over national banks,
but that law enforcement powers are separate and not preempted
by the National Bank Act. A State attorney general is required
to consult with the OCC before bringing an action against a
national bank or Federal savings association.
Section 1048. Effective date
Section 1048 provides that this subtitle becomes effective
on the designated transfer date.
Subtitle E--Enforcement Powers
Section 1051. Definitions
Section 1051 defines certain key terms for the purposes of
this subtitle.
Section 1052. Investigations and administrative discovery
Section 1052 provides the authority to the Bureau to issue
subpoenas for documents and testimony. It also authorizes
demands of materials and provides for confidential treatment of
demanded material. Section 1052 provides for petitions to
modify or set aside a demand, and for custodial control and
district court jurisdiction.
Section 1053. Hearings and adjudication proceedings
Section 1053 provides the authority to the Bureau to
conduct hearings and adjudication proceedings with special
rules for cease-and-desist proceedings, temporary cease-and-
desist proceedings, and for enforcement of orders in the United
States District Court.
Section 1054. Litigation authority
Section 1054 provides the authority to the Bureau to
commence civil action against a person who violates a provision
of this title or any enumerated consumer law, rule or order.
Section 1055. Relief available
Section 1055 provides for relief for consumers through
administrative proceedings and court actions for violations of
this title, including civil money penalties.
Section 1056. Referrals for criminal proceedings
Section 1056 authorizes the Bureau to transmit evidence of
conduct that may constitute a violation of Federal criminal law
to the Attorney General of the United States.
Section 1057. Employee protection
Section 1057 provides protection against firings of or
discrimination against employees who provide information or
testimony to the Bureau regarding violations of this title.
Section 1058. Effective date
Section 1058 provides that this subtitle becomes effective
on the designated transfer date.
Subtitle F--Transfer of Functions and Personnel and Transitional
Provisions
Section 1061. Transfer of consumer financial protection functions
Section 1061 transfers functions relating to consumer
financial protection from the Federal banking agencies (Federal
Reserve, OCC, OTS and FDIC) and NCUA, the Department of Housing
and Urban Development and the Federal Trade Commission to the
Bureau.
Section 1062. Designated transfer date
Section 1062 identifies the date of transfer of functions
to the Bureau as between 6 and 18 months after the date of
enactment of the CFP Act and subject to a six month extension.
It also requires that the transfer of functions be completed
not later than 2 years after the date of enactment of the CFP
Act.
Section 1063. Savings provision
Section 1063 clarifies that existing rights, duties,
obligations, orders, and rules of the Federal banking agencies,
the NCUA, the Department of Housing and Urban Development and
the Federal Trade Commission are not affected by the transfer.
Section 1064. Transfer of certain personnel
Section 1064 provides for the transfer of personnel from
various agencies to the Bureau and establishes employment and
pay protection for two years. It also provides for continuation
of benefits.
Section 1065. Incidental transfers
Section 1065 authorizes the Director of the Office of
Management and Budget, in consultation with the Secretary of
the Treasury, to make additional incidental transfers of assets
and liabilities of the various agencies. The authority in this
section terminates after 5 years.
Section 1066. Interim authority of the Secretary
Section 1066 provides the Secretary of the Treasury
authority to perform the functions of the Bureau under the CFP
Act until the Director of the Bureau is confirmed by the
Senate.
Section 1067. Transition oversight
Section 1067 ensures an orderly and organized creation of
the Bureau. It also requires the Bureau to submit an annual
report to Congress, which shall include plans for the
recruitment of a qualified workforce and a training and
development program.
Subtitle G--Regulatory Improvements
Section 1071. Collection of deposit account data
Section 1071 authorizes the collection of deposit account
data in order to promote awareness and understanding of the
access of individuals and communities to financial services,
and to identify business development needs and opportunities.
In developing the rules prescribed under Section 1071, the
Bureau should coordinate with the Federal banking regulators
and the National Credit Union Administration regarding the type
and form of the deposit account data, as well as the method of
collection, making every effort to avoid duplicative data
collection requirements and minimize additional regulatory
burden. Where substantially similar data is collected by the
appropriate Federal banking regulator or the National Credit
Union Administration, the Bureau should use this data. This
section becomes effective on the designated transfer date.
Section 1072. Small business data collection
Section 1072 authorizes the Bureau to collect data on small
businesses to facilitate enforcement of fair lending laws and
to enable communities, governmental entities and creditors to
identify business and community development needs and
opportunities for women-owned and minority-owned small
businesses. This section becomes effective on the designated
transfer date.
Section 1073. GAO study on the effectiveness and impact of various
appraisal methods
Section 1073 requires the GAO to conduct a study on various
appraisal methods and the extent to which the usage of such
methods impacts costs to consumers, conflicts of interest and
home price speculation.
Section 1074. Prohibition on certain prepayment penalties
Section 1074 prohibits prepayment penalties on all
residential mortgage loans that are not a qualified mortgage
and restricts them on qualified mortgages. Qualified mortgages
are defined to include residential mortgages that meet certain
criteria, in particular with respect to the application of
prepayment penalties.
Section 1075. Assistance for economically vulnerable individuals and
families
Section 1075 amends the Financial Education and Counseling
Grant Program established in the Housing and Economic Recovery
Act of 2008 by expanding the target audience beyond ``potential
homebuyers'' to ``economically vulnerable individuals and
families'' and deletes the 5 organization limit.
Section 1076. Remittance transfers
Section 1076 amends the Electronic Fund Transfer Act to
establish minimum protections for remittances sent by consumers
in the United States to other countries (remittance transfers).
Immigrants send substantial portions of their earnings to
family members abroad. These senders of remittance transfers
are not currently provided with adequate protections under
federal or state law. They face significant problems with their
remittance transfers, including being overcharged or not having
the funds reach intended recipients. This section will require
disclosures about the costs of sending remittance transfers to
be displayed in storefronts and to be provided to senders prior
to and after a transaction. An error resolution process for
remittance transfers is also established.
Specifically, this section will allow consumers to compare
costs by requiring remittance providers to post, on a daily
basis, a model transfer for the amounts of $100 and $200 in
their storefronts showing the amount of currency, including
fees, which would be received by the recipient of a remittance.
It also will require consumers sending remittances to be
provided with simple disclosures describing the amount of
currency for the designated recipient and a promised date of
delivery. In addition, it establishes an error resolution
process for remittances that are not properly transmitted.
Subtitle H--Conforming Amendments
Section 1081. Amendments to the Inspector General Act
Section 1081 makes conforming amendments to the Inspector
General Act to provide the Bureau with oversight by the
Inspector General of the Board of Governors. This section
becomes effective on the date of enactment of this Act.
Section 1082. Amendments to the Privacy Act of 1974
Section 1082 makes conforming amendments to the Privacy
Act. This section becomes effective on the date of enactment of
this Act.
Section 1083. Amendments to the Alternative Mortgage Transaction Parity
Act of 1982
Section 1083 makes conforming amendments to the Alternative
Mortgage Transaction Parity Act. The Alternative Mortgage
Parity Act was passed in 1982 to preempt State laws and
constitutions that prohibited adjustable rate mortgage (ARM)
loans for Federally-chartered and State chartered entities. It
also preempted State laws with respect to all ``alternative''
mortgages, including negative amortization loans and interest
only loans. States were unable to regulate terms for mortgages
which have proved to have had significant difficulty. The
amendment continues to preempt State laws that would prohibit
adjustable rate mortgages, but removes this preemption of other
types of ``alternative'' mortgages or features, permitting
States to legislate in this area.
Section 1084. Amendments to the Electronic Fund Transfer Act
Section 1084 makes conforming amendments to the Electronic
Fund Transfer Act.
Section 1085. Amendments to the Equal Credit Opportunity Act
Section 1085 makes conforming amendments to the Equal
Credit Opportunity Act.
Section 1086. Amendments to the Expedited Funds Availability Act
Section 1086 makes conforming amendments to the Expedited
Funds Availability Act. It also increases the next-day funds
availability amount under the Expedited Funds Availability Act
from $100 to $200, and allows future adjustments for inflation.
Section 1087. Amendments to the Fair Credit Billing Act
Section 1087 makes conforming amendments to the Fair Credit
Billing Act.
Section 1088. Amendments to the Fair Credit Reporting Act and the Fair
and Accurate Credit Transactions Act
Section 1088 makes conforming amendments to the Fair Credit
Reporting Act and the Fair and Accurate Credit Transaction Act.
Section 1089. Amendments to the Fair Debt Collection Practices Act
Section 1089 makes conforming amendments to the Fair Debt
Collection Practices Act.
Section 1090. Amendments to the Federal Deposit Insurance Act
Section 1090 makes conforming amendments to the Federal
Deposit Insurance Act.
Section 1091. Amendments to the Gramm-Leach-Bliley Act
Section 1091 makes conforming amendments to the Gramm-
Leach-Bliley Act.
Section 1092. Amendments to the Home Mortgage Disclosure Act
Section 1092 makes conforming and other amendments to the
Home Mortgage Disclosure Act. The amendments require new data
fields to be reported to the Bureau, including borrower age,
total points and fees information, loan pricing, prepayment
penalty information, house value for loan to value ratios,
period of introductory interest rate, interest-only or negative
amortization information, terms of the loan, channel of
origination, unique originator ID from the Secure and Fair
Enforcement for Mortgage Licensing Act, universal loan
identifier, parcel number to permit geocoding, and credit
score.
Section 1093. Amendments to the Home Owners Protection Act of 1998
Section 1093 makes conforming amendments to the Home Owners
Protection Act.
Section 1094. Amendments to the Home Ownership and Equity Protection
Act of 1994
Section 1094 makes conforming amendments to the Home
Ownership and Equity Protection Act.
Section 1095. Amendments to the Omnibus Appropriations Act, 2009
Section 1095 makes conforming amendments to the Omnibus
Appropriations Act, 2009.
Section 1096. Amendments to the Real Estate Settlement Procedures Act
Section 1096 makes conforming amendments to the Real Estate
Settlement Procedures Act.
Section 1097. Amendments to the Right to Financial Privacy Act of 1978
Section 1097 makes conforming amendments to the Right to
Financial Privacy Act.
Section 1098. Amendments to the Secure and Fair Enforcement for
Mortgage Licensing Act of 2008
Section 1098 makes conforming amendments to the Secure and
Fair Enforcement for Mortgage Licensing Act of 2008.
Section 1099. Amendments to the Truth in Lending Act
Section 1099 makes conforming amendments to the Truth in
Lending Act.
Section 1100. Amendments to the Truth in Savings Act
Section 1100 makes conforming amendments to the Truth in
Savings Act.
Section 1101. Amendments to the Telemarketing and Consumer Fraud and
Abuse Prevention Act
Section 1101 makes conforming amendments to the
Telemarketing and Consumer Fraud and Abuse Prevention Act.
Section 1102. Amendments to the Paperwork Reduction Act
Section 1102 makes conforming amendments to the Paperwork
Reduction Act.
Section 1103. Adjustment for inflation in the Truth in Lending Act
Section 1103 amends the Truth in Lending Act to cover
transactions of up to $50,000 and allows future adjustments for
inflation.
Section 1104. Effective date
Section 1104 provides that Sections 1083 through 1102
become effective on the designated transfer date.
Title XI--Federal Reserve System Provisions
Section 1151. Federal Reserve Act amendment on emergency lending
authority
This section amends Section 13(3) of the Federal Reserve
Act which governs emergency lending. Emergency lending to an
individual entity is no longer permitted. The Board of
Governors now is authorized to lend to a participant in any
program or facility with broad-based eligibility. Policies and
procedures governing emergency lending must be established by
regulation, in consultation with the Secretary of the Treasury.
The Treasury Secretary must approve the establishment of any
lending program. Lending programs must be designed to provide
liquidity and not to aid a failing financial company.
Collateral or other security for loans must be sufficient to
protect taxpayers from losses.
The Board of Governors must report to the Senate Committee
on Banking, Housing and Urban Affairs and the House Committee
on Financial Services on any 13(3) lending program within 7
days after it is initiated, and periodically thereafter. The
identities of recipients of emergency lending will be disclosed
within 1 year of receipt of assistance, unless the Federal
Reserve reports to Congress that disclosure would reduce the
effectiveness of the program or facility or have other serious
adverse effects, in which case the identities of recipients
will be disclosed no later than 1 year after the program
terminates. The GAO will report to Congress evaluating whether
a determination not to disclose recipient identities within a
year is reasonable.
Section 1152. Reviews of special Federal Reserve credit facilities
This section amends Section 714 of Title 31, United States
Code, to establish Comptroller General audits of emergency
lending by the Board of Governors of the Federal Reserve under
Section 13(3) of the Federal Reserve Act.
Section 1153. Public access to information
This section amends Section 2B of the Federal Reserve Act.
The Comptroller General audits of 13(3) lending established
under Section 1152 of this Act, the annual financial statements
prepared by an independent auditor for the Board of Governors,
and reports to the Senate Committee on Banking, Housing and
Urban Affairs on 13(3) lending established under Section 1151
of this Act will be displayed on a webpage that will be
accessed by an ``Audit'' link on the Board of Governors
website. The required information will be made available within
6 months of the date of release.
Sections 1154-1155. Emergency financial stabilization debt guarantees
The FDIC will be able to guarantee the debt of solvent
insured depositories and their holding companies under very
strict conditions. The Board of Governors of the Federal
Reserve and the Financial Stability Oversight Council must
determine that there is a ``liquidity event'' that failure to
take action would have serious adverse effects on financial
stability or economic conditions, and that guarantees are
needed to avoid or mitigate the adverse effects. The
determination must be in writing and is subject to GAO audit.
The FDIC may then set up a facility to guarantee debt,
following policies and procedures determined by regulation, but
the terms and conditions of the guarantees must be approved by
the Secretary of the Treasury.
The Secretary will determine a maximum amount of
guarantees, and the President may request Congress to allow
that amount. If the President does not submit the request, the
guarantees will not be made. Congress has 5 days to disapprove
the request. Fees for the guarantees are set to cover all
expected costs. If there are losses, they are recouped from
those firms that received guarantees.
Section 1156. Additional related amendments
The FDIC may not exercise its systemic risk authority to
establish any widely available debt guarantee program for which
Section 1155 would provide authority.
If any firm defaults on a debt guarantee provided under
section 1155, the FDIC shall appoint itself receiver of the
company if it is an insured depository. If the defaulting firm
is not an insured depository, the FDIC shall pursue one of two
alternatives. Under the first alternative the FDIC will require
consideration that the company be put into the resolution
mechanism pursuant to Section 203, and require that the company
file for bankruptcy if the FDIC is not appointed receiver
within 30 days. Under the second alternative the FDIC will file
a petition for involuntary bankruptcy on behalf of the
defaulting company.
Section 1157. Changes to Federal Reserve governance
The Federal Reserve Act is amended to state that a member
of the Board of Governors of the Federal Reserve shall serve as
Vice Chairman for Supervision. The Vice Chairman, who will be
designated by the President, by and with the advice and consent
of the Senate, will develop policy recommendations regarding
supervision and regulation for the Board, and will appear
before Congress semi-annually to report on the efforts,
objectives and plans of the Board with respect to the conduct
of supervision and regulation.
The Federal Reserve Act is amended to give the Board of
Governors of the Federal Reserve a formal responsibility to
identify, measure, monitor, and mitigate risks to U.S.
financial stability.
The Federal Reserve Act is amended to state explicitly that
the Board of Governors of the Federal Reserve may not delegate
to a Federal reserve bank its functions for establishing
supervisory and regulatory policy for bank holding companies
and other financial firms supervised by the Board.
To eliminate potential conflicts of interest at Federal
reserve banks, the Federal Reserve Act is amended to state that
no company, or subsidiary or affiliate of a company that is
supervised by the Board of Governors can vote for Federal
reserve bank directors; and the officers, directors and
employees of such companies and their affiliates cannot serve
as directors.
The Federal Reserve Act is amended to state that the
Federal Reserve Bank of New York president, who is currently
appointed by the district board of directors, will be appointed
by the President, by and with the advice and consent of the
Senate.
Title XII--Improving Access to Mainstream Financial Institutions
Section 1201. Short title
This section establishes the name of the title to be the
``Improving Access to Mainstream Financial Institutions Act.''
Section 1202. Purpose
This section establishes the purpose of this title to
encourage initiatives for financial products and services that
are appropriate and accessible for millions of Americans who
are not fully incorporated into the financial mainstream. The
Committee is concerned about lack of access to mainstream
financial institutions for significant numbers of unbanked or
underbanked individuals. About one in four families are
unbanked or underbanked. Many are low- and moderate-income
families that cannot afford to have their earnings diminished
by reliance on high-cost and often predatory financial products
and services. Underbanked consumers rely on non-traditional
forms of credit including payday lenders, title lenders, or
refund anticipation loans for financial needs. The unbanked are
unable to save securely for education expenses, a down payment
on a first home, or other future financial needs.
Section 1203. Definitions
Section 1204. Expanded access to mainstream financial institutions
Section 1204 authorizes programs intended to assist low-
and moderate-income individuals establish bank or credit union
accounts. This section authorizes the Treasury Secretary to
establish a multiyear program of grants, cooperative
agreements, financial agency agreements, and similar contracts
or undertakings to promote initiatives designed to expand
access to mainstream financial institutions by low and moderate
income individuals. Entities eligible under this program
include: 501(c)(3) organizations; federally insured depository
institutions; community development financial institutions;
State, local, or tribal government entities; and partnerships
or other joint ventures comprised of one or more of these such
entities. An eligible entity may, in participating in a program
established by the Secretary under this section, offer or
provide to low and moderate income individuals products or
services including small-dollar value loans and financial
education and counseling.
Section 1205. Low-cost alternatives to payday loans
Section 1205 will encourage the development of small,
affordable loans as an alternative to more costly, predatory,
payday loans. This section authorizes the Secretary to
establish multiyear demonstration programs by means of grants,
cooperative agreements, financial agency agreements, and
similar contracts or undertakings with eligible entities to
provide low-cost small loans to consumers that will provide
alternatives to payday loans. Loans under this section are
required to be made on terms and conditions and pursuant to
lending practices that are reasonable for consumers. The
authorization of a grant program under this section is intended
to encourage the further development of affordable small loans
that will assist working families by providing access to
reasonable credit and providing financial education
opportunities. Entities awarded a grant under this section are
required to promote financial literacy and education
opportunities, such as relevant counseling services,
educational courses, or wealth building programs, to each
consumer provided with a loan pursuant to this section.
Section 1206. Grants to establish loan-loss reserve funds
Section 1206 will enable Community Development Financial
Institutions to establish and maintain small dollar loan
programs by establishing a grant program within the CDFI Fund
to encourage affordable small dollar lending through loan-loss
reserve funds and provision of technical assistance. This
section directs the CDFI Fund to make grants to CDFIs to
establish loan-loss reserve funds to help CDFIs defray the
costs of operating small dollar loan programs in order to help
provide consumers access to mainstream financial institutions
and provide payday loan alternatives. Loan-loss reserve funds
enable financial institutions to maintain the necessary capital
to offer small dollar loans in a prudentially sound manner. A
CDFI receiving grants under this program must provide matching
funds equal to 50% of the amount of any grant received under
this section. Grants received by a CDFI under this section may
not be used to provide direct loans to consumers, and may be
used to help recapture a portion or all of a defaulted loan
made under the small dollar loan program.
This section further requires the Fund to provide technical
assistance grants to CDFIs to support and maintain small dollar
loan programs. Technical assistance grants help financial
institutions defray the initial fixed costs of establishing a
small dollar loan program and effectively implement grant
activities.
This section sets requirements for the terms and conditions
of loans made by participating institutions to ensure
affordability and help underserved consumers improve their
financial condition. Small dollar loan programs are defined as
loan programs where a CDFI offers loans to consumers that do
not exceed $2500; are required to be paid in installments; have
no prepayment penalty; report to at least one national consumer
reporting agency; and meet any other affordability requirement
established by the Administrator of the Fund.
Section 1207. Procedural provisions
This section requires an eligible entity desiring to
participate in a program or obtain a grant under this title to
submit an application to the Secretary.
Section 1208. Authorization of appropriations
This section authorizes to be appropriated to the
Secretary, such sums necessary to administer and fund the
programs and projects authorized by this title. It further
authorizes to be appropriated to the Fund for each fiscal year
beginning in FY 2010, an amount equal to the amount of the
administrative costs of the Fund for the operation of the grant
program established under this title.
Section 1209. Regulations
This section authorizes the Secretary to promulgate
regulations to implement and administer the grant programs and
undertakings authorized by this title, including limiting the
eligibility of entities as deemed appropriate for certain
activities authorized in Section 1204.
Section 1210. Evaluation and reports to Congress
This section requires the Secretary to submit a report to
the Senate Committee on Banking, Housing and Urban Affairs and
the House Financial Services Committee containing a description
of the activities funded, amounts distributed, and measurable
results, as appropriate and available.
VI. HEARING RECORD
Since the beginning of the 110th Congress, the Committee on
Banking, Housing, and Urban Affairs has held 79 hearings on
topics surrounding the housing and economic crisis and
financial regulatory reform.
Preserving the American Dream: Predatory Lending Practices
and Home Foreclosures
Wednesday, February 7, 2007
Witnesses: The Reverend Jesse Jackson, President and
Founder, RainbowPUSH Coalition; Mr. Harry H. Dinham, President,
National Association of Mortgage Brokers; Mr. Hilary Shelton,
Executive Director, National Association for the Advancement of
Colored People; Mr. Martin Eakes, Chief Executive Officer,
Self-Help Credit Union and the Center for Responsible Lending;
Ms. Jean Constantine-Davis, Senior Attorney, AARP; Mr. Douglas
G. Duncan, Senior Vice President of Research and Business
Development, and Chief Economist, Mortgage Bankers Association;
Ms. Delores King, Consumer, Ms. Amy Womble, Consumer.
Mortgage Market Turmoil: Causes and Consequences
Thursday, March 22, 2007
Witnesses:
Panel 1: Mr. Emory W. Rushton, Senior Deputy Comptroller
and Chief National Bank Examiner, Office of the Comptroller of
the Currency; Mr. Joseph A. Smith, North Carolina Commissioner
of Banks and Chairman, Conference of State Bank Supervisors;
Mr. Roger T. Cole, Director, Division of Banking Supervision
and Regulation, Board of Governors of the Federal Reserve
System; Mr. Scott M. Polakoff, Senior Deputy Director and Chief
Operating Officer, Office of Thrift Supervision; Ms. Sandra
Thompson, Director of the Division of Supervision and Consumer
Protection, Federal Deposit Insurance Corporation.
Panel 2: Mr. Brendan McDonagh, Chief Executive Officer,
HSBC Finance Corporation; Mr. Sandy Samuels, Executive Managing
Director, Countrywide Financial Corporation; Mr. Laurent
Bossard, Chief Executive Officer, WMC Mortgage; Mr. L. Andrew
Pollock, President, First Franklin Financial Corporation; Ms.
Janis Bowdler, Senior Policy Analyst, National Council of La
Raza; Mr. Irv Ackelsberg, Consumer Attorney; Ms. Jennie
Haliburton, Consumer; Mr. Al Ynigues, Borrower.
Subprime Mortgage Market Turmoil: Examining the Role of
Securitization
Tuesday, April 17, 2007
Witnesses: Mr. Gyan Sinha, Senior Managing Director and
Head of ABS and CDO Research, Bear Stearns & Co. Inc.; Mr.
David Sherr, Managing Director and Head of Securitized
Products, Lehman Brothers; Ms. Susan Barnes, Managing Director
of Ratings Services, Standard and Poor's; Mr. Warren Kornfeld,
Managing Director, Residential Mortgage-Backed Securities
Rating Group, Moody's Investors Service; Mr. Kurt Eggert,
Professor of Law, Chapman University School of Law; Mr.
Christopher L. Peterson, Assistant Professor of Law, Levin
College of Law, University of Florida.
Ending Mortgage Abuse: Safeguarding Homebuyers
Tuesday, June 26, 2007
Witnesses: Mr. David Berenbaum, Executive Vice President,
National Community Reinvestment Coalition; Professor Anthony
Yezer, Department of Economics, George Washington University;
Ms. Denise Leonard, Chairman and CEO, Constitution Financial
Group, Inc. on behalf of the National Association of Mortgage
Brokers; Mr. John Robbins, Chairman, Mortgage Bankers
Association; Mr. Wade Henderson, President and CEO, Leadership
Conference on Civil Rights; Mr. Alan Hummel, Senior Vice
President and Chief Appraiser, Forsythe Appraisals, LLC on
behalf of the Appraisal Institute; Mr. Pat V. Combs, President,
National Association of REALTORS; Mr. Michael D. Calhoun,
President, Center For Responsible Lending.
The State of the Securities Markets
Tuesday, July 31, 2007
Witnesses: Honorable Christopher Cox, Chairman, Securities
and Exchange Commission.
The Role and Impact of Credit Rating Agencies on the
Subprime Credit Markets
Wednesday, September 26, 2007
Witnesses
Panel 1: Honorable Christopher Cox, Chairman, Securities
and Exchange Commission.
Panel 2: Mr. John Coffee, Adolf A. Berle Professor of Law,
Columbia Law School; Dr. Lawrence J. White, Leonard E.
Imperatore Professor of Economics, New York University; Mr.
Micheal Kanef, Group Managing Director, Assett Finance Group,
Moody's Financial Services; Ms. Vickie A. Tillman, Executive
Vice President for Credit Market Services, Standard & Poor's.
Strengthening our Economy: Foreclosure Prevention and
Neighborhood Preservation
Thursday, January 31, 2008
Witnesses
Panel 1: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Robert Steel, Under Secretary of
Treasury for Domestic Finance, Department of the Treasury.
Panel 2: Doris Koo, President and CEO, Enterprise Community
Partners, Inc; Michael Barr, Senior Fellow, Center for American
Progress, and Professor of Law, University of Michigan Law
School; Mr. Wade Henderson, President and CEO, Leadership
Conference on Civil Rights; Mr. Alex Pollock, Resident Fellow,
American Enterprise Institute.
The State of the United States Economy and Financial
Markets
Thursday, February 14, 2008
Witnesses: Honorable Henry M. Paulson, Secretary of the
Treasury; Honorable Christopher Cox, Chairman, Securities and
Exchange Commission; Honorable Ben S. Bernanke, Chairman, Board
of Governors of the Federal Reserve System.
The State of the Banking Industry
Tuesday, March 4, 2008
Witnesses: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Honorable John C. Dugan, Comptroller of
the Currency, United States Treasury; Honorable John M. Reich,
Director, Office of Thrift Supervision; Honorable JoAnn
Johnson, Chairman, National Credit Union Administration;
Honorable Donald Kohn, Vice Chairman, Board of Governors,
Federal Reserve System; Mr. Thomas B. Gronstal, Superintendent
of Banking, State of Iowa.
Turmoil in U.S. Credit Markets: Examining the Recent
Actions of Federal Financial Regulators
Thursday, April 3, 2008
Witnesses
Panel 1: The Honorable Ben S. Bernanke, Chairman, Board of
Governors of the Federal Reserve System; Honorable Christopher
Cox, Chairman, Securities and Exchange Commission; Robert
Steel, Under Secretary of Treasury for Domestic Finance,
Department of the Treasury; Mr. Timothy F. Geithner, President,
Federal Reserve Bank of New York.
Panel 2: Mr. James Dimon, Chairman and Chief Executive
Officer, JP Morgan Chase; Mr. Alan D. Schwartz, President and
Chief Executive Officer, The Bear Stearns Companies, Inc.
Restoring the American Dream: Solutions to Predatory
Lending and the Foreclosure Crisis
Monday, April 7, 2008
Witnesses: The Honorable Michael Nutter, Mayor of
Philadelphia, Pennsylvania; Ms. Yajaira Rivera, Philadelphia,
Pennsylvania; Ms. Christina Anderson-Jones, Philadelphia,
Pennsylvania; Ph.D. Ira Goldstein, Director, Policy and
Information Services, The Reinvestment Fund; Mr. Brian A.
Hudson, Sr., Executive Director, Pennsylvania House Finance
Agency.
Turmoil in U.S. Credit Markets: Examining Proposals to
Mitigate Foreclosures and Restore Liquidity to the Mortgage
Markets
Thursday, April 10, 2008
Witnesses: Dr. Lawrence H. Summers, Charles W. Eliot
University Professor, Harvard University; Dr. Dean Baker, Co-
Director, Center for Economic and Policy Research; Ms. Ellen
Harnick, Senior Policy Counsel, Center for Responsible Lending;
Mr. Scott Stern, Chief Executive Officer, Lenders One,
Incorporated; Dr. Douglas Elmendorf, Senior Fellow, The
Brookings Institution.
Turmoil in U.S. Credit Markets Impact on the Cost and
Availability of Student Loans
Tuesday, April 15, 2008
Witnesses: John (Jack) F. Remondi, Vice Chairman and Chief
Financial Officer, Sallie Mae, Inc.; Mr. Tom Deutsch, Deputy
Executive Director, American Securitization Forum; Ms. Patricia
McGuire, President, Trinity Washington University; Ms. Sarah
Flanagan, Vice President for Policy Development, National
Association of Independent Colleges and Universities; Mark
Kantrowitz, Publisher, FinAid.org.
Turmoil in U.S. Credit Markets: Examining Proposals to
Mitigate Foreclosures and Restore Liquidity to the Mortgage
Markets
Wednesday, April 16, 2008
Witnesses: Honorable Brian D. Montgomery, Federal Housing
Commissioner and Assistant Secretary, Department of Housing and
Urban Development; Mr. Art Murton, Director, Division of
Insurance and Research, Federal Deposit Insurance Corporation;
Mr. Scott M. Polakoff, Senior Deputy Director and Chief
Operating Officer, Office of Thrift Supervision.
Turmoil in U.S. Credit Markets: The Role of the Credit
Rating Agencies
Tuesday, April 22, 2008
Witnesses
Panel 1: Honorable Christopher Cox, Chairman, Securities
and Exchange Commission.
Panel 2: Professor John C. Coffee, Jr., Adolf A. Berle
Professor of Law, Columbia University Law School; Dr. Arturo
Cifuentes, Managing Director, R.W. Pressprich & Co.; Mr.
Stephen W. Joynt, President and Chief Executive Officer, Fitch
Ratings; Ms. Claire Robinson, Senior Managing Director, Moody's
Investors Service; Ms. Vickie A. Tillman, Executive Vice
President for Credit Market Services, Standard & Poor's.
Turmoil in U.S. Credit Markets: Examining the U.S.
Regulatory Framework for Assessing Sovereign Investments
Thursday, April 24, 2008
Witnesses
Panel 1: Mr. Scott Alvarez, General Counsel, Board of
Governors of the Federal Reserve System; Mr. Ethiopis Tafara,
Director, Office of International Affairs, Securities and
Exchange Commission.
Panel 2: Mr. David Marchick, Managing Director, The Carlyle
Group; Mr. Paul Rose, Assistant Professor of Law, Moritz
College of Law, Ohio State University; Ms. Jeanne S. Archibald,
Partner, Hogan and Hartson LLP; Mr. Dennis Johnson, Director of
Corporate Governance, California Public Employees' Retirement
System.
Turmoil in the U.S. Credit Markets: Examining the
Regulation of Investment Banks by the U.S. Securities and
Exchange Commission
Wednesday, May 7, 2008
Witnesses
Panel 1: Mr. Erik Sirri, Director, Division of Market
Regulation, Securities and Exchange Commission.
Panel 2: Honorable Arthur Levitt, Former Chairman, U.S.
Securities and Exchange Commission; Mr. David Ruder, Former
Chairman, U.S. Securities and Exchange Commission.
The State of the Banking Industry: Part II
Thursday, June 5, 2008
Witnesses: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Honorable John C. Dugan, Comptroller of
the Currency, United States Treasury; Honorable John M. Reich,
Director, Office of Thrift Supervision; Honorable JoAnn
Johnson, Chairman, National Credit Union Administration;
Honorable Donald Kohn, Vice Chairman, Board of Governors,
Federal Reserve System; Mr. Timothy J. Karsky, Commissioner/
Chairman, North Dakota Department of Financial Institutions/
Conference of State Bank Supervisors.
Risk Management and its Implications for Systemic Risk
Thursday, June 19, 2008
Witnesses: Honorable Donald Kohn, Vice Chairman, Board of
Governors, Federal Reserve System; Dr. Erik Sirri, Director,
Division of Trading and Markets, U.S. Securities and Exchange
Commission; Mr. Scott M. Polakoff, Deputy Director, Office of
Thrift Supervision; Mr. Richard Bookstaber, Financial Author;
Professor Richard Herring, Jacob Safra Professor of
International Banking and Co-Director of the Wharton Financial
Institutions Center, Wharton School, University of
Pennsylvania; Mr. Kevin Blakely, President and Chief Executive
Officer, Risk Management Association.
Reducing Risks and Improving Oversight in the OTC Credit
Derivatives Market
Wednesday, July 9, 2008
Witnesses: Mr. Patrick Parkinson, Deputy Director, Division
of Research and Statistics, Board of Governors of the Federal
Reserve System; Mr. James Overdahl, Senior Economist, U.S.
Securities and Exchange Commission; Ms. Kathryn E. Dick, Deputy
Comptroller for Credit and Market Risk, Office of the
Comptroller of the Currency; Dr. Darrell Duffie, Dean Witter
Distinguished Professor of Finance, Stanford University,
Graduate School of Business; Mr. Craig Donohue, Chief Executive
Officer, Chicago Mercantile Exchange Group; Mr. Edward J.
Rosen, Cleary Gottlieb Steen & Hamilton LLP, Outside Counsel to
The Clearing Corporation; Mr. Robert G. Pickel, Executive
Director and Chief Executive Officer, International Swaps and
Derivatives Association, Inc.
Recent Developments in U.S. Financial Markets and
Regulatory Responses to Them
Tuesday, July 15, 2008
Witnesses: Honorable Henry M. Paulson, Secretary of the
Treasury; The Honorable Ben S. Bernanke, Chairman, Board of
Governors of the Federal Reserve System; Honorable Christopher
Cox, Chairman, Securities and Exchange Commission.
State of the Insurance Industry: Examining the Current
Regulatory and Oversight Structure
Tuesday, July 29, 2008
Witnesses
Panel 1: Honorable Steven M. Goldman, Commissioner, New
Jersey Department of Banking and Insurance, on behalf of the
National Association of Insurance Commissioners; Mr. Travis B.
Plunkett, Legislative Director, Consumer Federation of America;
Mr. Alessandro Iuppa, Senior Vice President, Zurich North
America, on behalf of the American Insurance Association; Mr.
John L. Pearson, Chairman, President, and Chief Executive
Officer, The Baltimore Life Insurance Company, on behalf of the
American Council of Life Insurers.
Panel 2: Mr. George A. Steadman, President and Chief
Operating Officer, Rutherfoord Inc., on behalf of the Council
of Insurance Agents & Brokers; Mr. Thomas Minkler, President,
Clark-Mortenson Agency, Inc., on behalf of the Independent
Insurance Agents & Brokers of America; Mr. Franklin Nutter,
President, Reinsurance Association of America; Mr. Richard
Bouhan, Executive Director, National Association of
Professional Surplus Lines Offices.
Transparency in Accounting: Proposed Changes to Accounting
for Off-Balance Sheet Entities
Thursday, September 18, 2008
Witnesses
Panel 1: Mr. Lawrence Smith, Board Member, Financial
Accounting Standards Board (FASB); Mr. John White, Director,
Office of Corporate Finance, Securities and Exchange
Commission; Mr. James Kroeker, Deputy Chief Accountant for
Accounting, U.S. Securities and Exchange Commission.
Panel 2: Professor Joseph Mason, Hermann Moyse Jr. Endowed
Chair of Banking, E.J. Ourso College of Business, Louisiana
State University; Mr. Donald Young, Managing Director, Young
and Company LLC, and former FASB Board Member; Ms. Elizabeth
Mooney, Analyst, Capital Strategy Research, The Capital Group;
Mr. George Miller, Executive Director, American Securitization
Forum.
Turmoil in US Credit Markets Recent Actions Regarding
Government Sponsored Entities, Investment Banks and Other
Financial Institutions
Tuesday, September 23, 2008
Witnesses: Honorable Henry M. Paulson, Secretary of the
Treasury; The Honorable Ben S. Bernanke, Chairman, Board of
Governors of the Federal Reserve System; Honorable Christopher
Cox, Chairman, Securities and Exchange Commission; Honorable
James B. Lockhart, III, Director, Federal Housing Finance
Agency.
Turmoil in the U.S. Credit Markets: The Genesis of the
Current Economic Crisis
Thursday, October 16, 2008
Witnesses: Honorable Arthur Levitt, Jr., Senior Advisor,
The Carlyle Group; Honorable Eugene A. Ludwig, Chief Executive
Officer, Promontory Financial Group; Honorable Jim Rokakis,
Treasurer, Cuyahoga County, Ohio; Honorable Marc H. Morial,
President and CEO, National Urban League; Mr. Eric Stein,
Senior Vice President, Center for Responsible Lending.
Turmoil in the U.S. Credit Markets: Examining Recent
Regulatory Responses
Thursday, October 23, 2008
Witnesses: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Honorable Neel Kashkari, Interim
Assistant Secretary for Financial Stability and Assistant
Secretary for International Affairs, U.S. Department of the
Treasury; Honorable James B. Lockhart, III, Director, Federal
Housing Finance Agency; Honorable Elizabeth A. Duke, Governor,
Board of Governors of the Federal Reserve System; Honorable
Brian D. Montgomery, Federal Housing Commissioner and Assistant
Secretary, Department of Housing and Urban Development.
Oversight of the Emergency Economic Stabilization Act:
Examining Financial Institution Use of Funding Under the
Capital Purchase Program
Thursday, November 13, 2008
Witnesses: Ms. Anne Finucane, Global Corporate Affairs
Executive, Bank of America; Mr. Barry L. Zubrow, Executive Vice
President, Chief Risk Officer, JPMorgan Chase; Mr. Jon
Campbell, Executive Vice President, Chief Executive Officer of
the Minnesota Region, Wells Fargo Bank; Mr. Gregory Palm,
Executive Vice President and General Counsel, The Goldman Sachs
Group, Inc.; Mr. Martin Eakes, Chief Executive Officer, Self-
Help Credit Union and the Center for Responsible Lending; Nancy
M. Zirkin, Director of Public Policy, Leadership Conference on
Civil Rights; Dr. Susan M. Wachter, Worley Professor of
Financial Management, Wharton School of Business, University of
Pennsylvania.
Examining the State of the Domestic Automobile Industry
Tuesday, November 18, 2008
Witnesses
Panel 1: Honorable Debbie Stabenow (D-MI), United States
Senator.
Panel 2: Mr. Ron Gettelfinger, President, International
Union, United Automobile, Aerospace and Agricultural Implement
Workers of America; Mr. Alan Mulally, President and Chief
Executive Officer, Ford Motor Company; Mr. Robert Nardelli,
Chairman and Chief Executive Officer, Chrysler LLC; Mr. G.
Richard Wagoner, Jr., Chairman and Chief Executive Officer,
General Motors; Dr. Peter Morici, Professor, Robert H. Smith
School of Business, University of Maryland.
The State of the Domestic Automobile Industry: Part II
Thursday, December 4, 2008
Witnesses
Panel 1: Mr. Gene L. Dodaro, Acting Comptroller General,
United States Government Accountability Office.
Panel 2: Mr. Ron Gettelfinger, President, International
Union, United Automobile, Aerospace and Agricultural Implement
Workers of America; Mr. Alan Mulally, President and Chief
Executive Officer, Ford Motor Company; Mr. Robert Nardelli,
Chairman and Chief Executive Officer, Chrysler LLC; Mr. G.
Richard Wagoner, Jr., Chairman and Chief Executive Officer,
General Motors; Mr. Keith Wandell, President, Johnson Controls,
Inc.; Mr. James Fleming, President, Connecticut Automotive
Retailers Association; Dr. Mark Zandi, Chief Economist and
Cofounder, Moody's Economy.com.
Madoff Investment Securities Fraud: Regulatory and
Oversight Concerns and the Need for Reform
Tuesday, January 27, 2009
Witnesses: Professor John C. Coffee, Jr., Adolf A. Berle
Professor of Law, Columbia University Law School; Dr. Henry A.
Backe, Jr., Orthopedic Surgeon, Fairfield, Connecticut; Ms.
Lori Richards, Director, Office of Compliance Inspections and
Examinations, U.S. Securities and Exchange Commission; Ms.
Linda Thomsen, Director, Division of Enforcement, U.S.
Securities and Exchange Commission; Mr. Stephen Luparello,
Interim Chief Executive Officer, Financial Industry Regulatory
Authority; Mr. Stephen Harbeck, Interim Chief Executive
Officer, Financial Industry Regulatory Authority.
Modernizing the U.S. Financial Regulatory System
Wednesday, February 4, 2009
Witnesses
Panel 1: Honorable Paul A. Volcker, Chair of the
President's Economic Recovery Advisory Board, Former Chairman,
Board of Governors of the Federal Reserve System.
Panel 2: Mr. Gene L. Dodaro, Acting Comptroller General,
United States Government Accountability Office.
Pulling Back the TARP: Oversight of the Financial Rescue
Program
Thursday, February 5, 2009
Witnesses: Mr. Gene L. Dodaro, Acting Comptroller General,
United States Government Accountability Office; Honorable Neil
M. Barofsky, Special Inspector General, Troubled Asset Relief
Program; Professor Elizabeth Warren, Chair, Congressional
Oversight Panel for the Troubled Asset Relief Program.
Oversight of the Financial Rescue Program: A New Plan for
the TARP
Tuesday, February 10, 2009
Witnesses: Honorable Timothy Geithner, Secretary, United
States Department of the Treasury.
Modernizing Consumer Protection in the Financial Regulatory
System: Strengthening Credit Card Protections
Thursday, February 12, 2009
Witnesses: Mr. Travis B. Plunkett, Legislative Director,
Consumer Federation of America; Mr. James C. Sturdevant, Esq.,
The Sturdevant Law Firm; Mr. Kenneth J. Clayton, Senior Vice
President and General Counsel, Card Policy Council, American
Bankers Association; Lawrence M. Ausubel, Professor of
Economics, University of Maryland; Mr. Todd Zywicki, Professor,
George Mason University School of Law; Mr. Adam J. Levitin,
Associate Professor of Law, Georgetown University Law Center.
Homeowner Affordability and Stability Plan
Thursday, February 26, 2009
Witnesses: Honorable Shaun Donovan, Secretary, U.S.
Department of Housing and Urban Development.
Consumer Protections in Financial Services: Past Problems,
Future Solutions
Tuesday, March 3, 2009
Witnesses: Mr. Steve Bartlett, President and CEO, Financial
Services Roundtable; Honorable Ellen Seidman, Senior Fellow of
New America Foundation, Executive Vice President of ShoreBank
Corporation; Professor Patricia McCoy, George J. & Helen M.
England Professor of Law, University of Connecticut School of
Law.
American International Group: Examining What Went Wrong,
Government Intervention, and Implications for Future Regulation
Thursday, March 5, 2009
Witnesses: Honorable Donald Kohn, Vice Chairman, Board of
Governors, Federal Reserve System; Mr. Scott M. Polakoff,
Senior Deputy Director and Chief Operating Officer, Office of
Thrift Supervision; Mr. Eric Dinallo, Superintendent, New York
State Insurance Department.
Enhancing Investor Protection and the Regulation of
Securities Markets
Tuesday, March 10, 2009
Witnesses: Mr. John Coffee, Adolf A. Berle Professor of
Law, Columbia Law School; Mr. Lynn E. Turner, Former Chief
Accountant, U.S. Securities and Exchange Commission; Mr.
Timothy Ryan, President and CEO, Securities Industry and
Financial Markets Association; Mr. Paul Schott Stevens,
President and CEO, Investment Company Institute: Professor
Mercer Bullard, Associate Professor and President, University
of Mississippi School of Law and Fund Democracy; Mr. Robert G.
Pickel, Executive Director and Chief Executive Officer,
International Swaps and Derivatives Association, Inc.; Mr.
Damon Silvers, Associate General Counsel, AFL-CIO; Thomas G.
Doe, CEO, Municipal Market Advisors.
Perspectives on Modernizing Insurance Regulation
Tuesday, March 17, 2009
Witnesses: Mr. Michael McRaith, Director of Insurance,
Illinois Department of Financial and Professional Regulation,
on behalf of the National Association of Insurance
Commissioners; Honorable Frank Keating, President and Chief
Executive Officer, The American Council of Life Insurers; Mr.
William R. Berkley, Chairman and Chief Executive Officer, W. R.
Berkley Corporation, on behalf of the American Insurance
Association; Mr. Spencer Houldin, President, Ericson Insurance
Services, on behalf of the Independent Insurance Agents and
Brokers of America; Mr. John Hill, President and Chief
Operating Officer, Magna Carta Companies, on behalf of the
National Association of Mutual Insurance Companies; Mr. Frank
Nutter, President, The Reinsurance Association of America; Mr.
Robert Hunter, Director of Insurance, The Consumer Federation
of America.
Lessons Learned in Risk Management Oversight at Federal
Financial Regulators
Wednesday, March 18, 2009
Witnesses: Mr. Scott M. Polakoff, Acting Director, Office
of Thrift Supervision; Ms. Orice Williams, Director, Financial
Markets and Community Investment, Government Accountability
Office; Mr. Roger Cole, Director, Division of Banking
Supervision and Regulation, Federal Reserve Board; Mr. Timothy
Long, Senior Deputy Comptroller, Bank Supervision Policy and
Chief National Bank Examiner, Office of the Comptroller of the
Currency; Dr. Erik Sirri, Director, Division of Trading and
Markets, U.S. Securities and Exchange Commission.
Modernizing Bank Supervision and Regulation
Thursday, March 19, 2009
Witnesses: Honorable John C. Dugan, Comptroller of the
Currency, Office of the Comptroller of the Currency; Honorable
Daniel K. Tarullo, Member, Board of Governors of the Federal
Reserve System; Honorable Sheila Bair, Chairman, Federal
Deposit Insurance Corporation; Honorable Michael E. Fryzel,
Chairman, National Credit Union Administration; Mr. Scott M.
Polakoff, Acting Director, Office of Thrift Supervision; Mr.
Joseph A. Smith, North Carolina Commissioner of Banks and
Chairman, Conference of State Bank Supervisors; Mr. George
Reynolds, Chairman, National Association of State Credit Union
Supervisors and Senior Deputy Commissioner, Georgia Department
of Banking and Finance.
Current Issues in Deposit Insurance
Thursday, March 19, 2009
Witnesses
Panel 1: Mr. Art Murton, Director, Division of Insurance
and Research, Federal Deposit Insurance Corporation; Mr. David
M. Marquis, Executive Director, National Credit Union
Administration.
Panel 2: Mr. William Grant, Chairman & CEO, First United
Bank and Trust, Oakland, Maryland, on behalf of the American
Bankers Association; Mr. Terry West, President and CEO, VyStar
Credit Union in Jacksonville, Florida, on behalf of the Credit
Union National Association; Mr. Steve Verdier, Senior Vice
President, Independent Community Bankers of America; Mr. David
J. Wright, CEO, Services Credit Union, Yankton, South Dakota,
on behalf of the National Association of Federal Credit Unions.
Modernizing Bank Supervision and Regulation, Part II
Tuesday, March 24, 2009
Witnesses: Mr. William Attridge, President, Chief Executive
Officer and Chief Operating Officer, Connecticut River
Community Bank, on behalf of the Independent Community Bankers
of America; Mr. Daniel A. Mica, President and Chief Executive
Officer, Credit Union National Association; Mr. Aubrey
Patterson, Chairman and Chief Executive Officer, BancorpSouth,
Inc., on behalf of the American Bankers Association; Mr.
Christopher Whalen, Managing Director, Institutional Risk
Analytics; Ms. Gail Hillebrand, Senior Attorney, Consumers
Union of U.S., Inc.
Enhancing Investor Protection and the Regulation of
Securities Markets--Part II
Thursday, March 26, 2009
Witnesses
Panel 1: Honorable Mary Schapiro, Chairman, U.S. Securities
and Exchange Commission; Honorable Fred Joseph, President,
North American Securities Administrators Association.
Panel 2: Honorable Richard C. Breeden, Former Chairman,
U.S. Securities and Exchange Commission; Honorable Arthur
Levitt, Former Chairmen, U.S. Securities and Exchange
Commission; Honorable Paul S. Atkins, Former Commissioner, U.S.
Securities and Exchange Commission.
Panel 3: Mr. Richard Ketchum, Chairman and CEO, FINRA; Mr.
Ronald A. Stack, Chair, Municipal Securities Rulemaking Board;
Honorable Richard Baker, President and CEO, Managed Funds
Association; Mr. James Chanos, Chairman, Coalition of Private
Investment Companies; Ms. Barbara Roper, Director of Investor
Protection, Consumer Federation of America; Mr. David G.
Tittsworth, Executive Director and Executive Vice President,
Investment Adviser Association; Ms. Rita Bolger, Senior Vice
President and Associate General Counsel, Standard & Poor's,
Global Regulatory Affairs; President Daniel Curry, President,
DBRS, Inc.
Lessons from the New Deal
Tuesday, March 31, 2009
Witnesses
Panel 1: Honorable Christina Romer, Chair, Council of
Economic Advisors.
Panel 2: Dr. James K. Galbraith, Lloyd M. Bentsen Chair,
Lyndon B. Johnson School of Public Affairs, University of Texas
at Austin; Dr. J. Bradford DeLong, Professor of Economics,
University of California Berkeley; Dr. Allan M. Winkler,
Professor of History, Miami (Ohio) University; Dr. Lee E.
Ohanian, Professor, University of California, Los Angeles.
Regulating and Resolving Institutions Considered `Too Big
to Fail'
Wednesday, May 6, 2009
Witnesses
Panel 1: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Mr. Gary Stern, President, Federal
Reserve Bank of Minneapolis.
Panel 2: Honorable Peter Wallison, Arthur F. Burns Fellow
in Financial Policy Studies, American Enterprise Institute;
Honorable Martin N. Baily, Senior Fellow, Economic Studies, The
Brookings Institution; Mr. Raghuram G. Rajan, Eric J. Gleacher
Distinguished Service Professor of Finance, University of
Chicago Booth School of Business.
Strengthening the S.E.C.'s Vital Enforcement
Responsibilities
Thursday, May 7, 2009
Witnesses: Mr. Richard Hillman, Managing Director,
Financial Markets and Community Investment, U.S. Government
Accountability Office; Robert Khuzami, Esq., Director, Division
of Enforcement, U.S. Securities and Exchange Commission;
Professor Mercer Bullard, Associate Professor of Law,
University of Mississippi School of Law; Mr. Bruce Hiler,
Partner and Head of Securities Enforcement Group, Cadwalader,
Wickersham and Taft LLP.
Manufacturing and the Credit Crisis
Wednesday, May 13, 2009
Witnesses
Panel 1: Mr. Leo Gerard, President, United Steelworkers;
Mr. David Marchick, Managing Director, The Carlyle Group.
Panel 2: Mr. Eugene Haffely, CEO, Assembly and Test
Worldwide, Inc.; Lieutenant General Larry Farrell, (USAF,
Retired) President, National Defense Industrial Association;
Mr. William Gaskin, President, Precision Metalforming
Association.
Oversight of the Troubled Assets Relief Program
Wednesday, May 20, 2009
Witnesses: Honorable Timothy Geithner, Secretary, United
States Department of the Treasury.
The State of the Domestic Automobile Industry: Impact of
Federal Assistance
Wednesday, June 10, 2009
Witnesses: Mr. Ron Bloom, Senior Advisor on the Auto
Industry, U.S. Department of the Treasury; The Honorable Edward
Montgomery, White House Director of Recovery for Auto
Communities and Workers, The White House.
The Administration's Proposal to Modernize the Financial
Regulatory System
Thursday, June 18, 2009
Witnesses: Honorable Timothy Geithner, Secretary, United
States Department of the Treasury.
Over-the-Counter Derivatives: Modernizing Oversight to
Increase Transparency and Reduce Risks
Monday, June 22, 2009
Witnesses
Panel 1: Honorable Mary Schapiro, Chairman, U.S. Securities
and Exchange Commission; Honorable Gary Gensler, Chairman, U.S.
Commodity Futures Trading Commission; Ms. A. Patricia White,
Associate Director of the Division of Research and Statistics,
Board of Governors of the Federal Reserve System.
Panel 2: Dr. Henry Hu, Allan Shivers Chair in the Law of
Banking and Finance, University of Texas School of Law; Mr.
Kenneth C. Griffin, Founder, President, and Chief Executive
Officer, Citadel Investment Group, L.L.C.; Mr. Robert G.
Pickel, Executive Director and Chief Executive Officer,
International Swaps and Derivatives Association, Inc.; Mr.
Christopher Whalen, Managing Director, Institutional Risk
Analytics.
The Effects of the Economic Crisis on Community Banks and
Credit Unions in Rural Communities
Wednesday, July 8, 2009
Witnesses: Mr. Jack Hopkins, President and Chief Executive
Officer, CorTrust Bank National Association, Sioux Falls, SD on
behalf of the Independent Community Bankers of America; Mr.
Frank Michael, President and CEO, Allied Credit Union,
Stockton, CA on behalf of the Credit Union National
Association; Mr. Arthur Johnson, Chairman and CEO, United Bank
of Michigan, Grand Rapids, MI on behalf of the American Bankers
Association; Mr. Ed Templeton, President and CEO, SRP Federal
Credit Union, North Augusta, SC; Mr. Peter Skillern, Executive
Director, Community Reinvestment Association of North Carolina.
Creating a Consumer Financial Protection Agency: A
Cornerstone of America's New Economic Foundation
Tuesday, July 14, 2009
Witnesses
Panel 1: Honorable Michael S. Barr, Assistant Secretary for
Financial Institutions, U.S. Department of the Treasury.
Panel 2: Honorable Richard Blumenthal, Attorney General,
State of Connecticut; Mr. Edward Yingling, President and CEO,
American Bankers Association; Mr. Travis B. Plunkett,
Legislative Director, Consumer Federation of America; Honorable
Peter Wallison, Arthur F. Burns Fellow in Financial Policy
Studies, American Enterprise Institute; Mr. Sendhil
Mullainathan, Professor of Economics, Harvard University.
Regulating Hedge Funds and Other Private Investment Pools
Wednesday, July 15, 2009
Witnesses
Panel 1: Mr. Andrew J. Donohue, Director of the Division of
Investment Management, U.S. Securities and Exchange Commission.
Panel 2: Mr. Dinakar Singh, Founder and Chief Executive
Officer, TPG Axon Capital; Mr. James Chanos, Chairman,
Coalition of Private Investment Companies; Mr. Trevor R. Loy,
General Partner, Flywheel Ventures; Mr. Mark B. Tresnowski,
Managing Director and General Counsel, Madison Dearborn
Partners, LLC; Mr. Richard Bookstaber, Financial Author; Mr.
Joseph Dear, Chief Investment Officer, California Public
Employees' Retirement System.
Preserving Homeownership: Progress Needed to Prevent
Foreclosures
Thursday, July 16, 2009
Witnesses
Panel 1: Honorable Herbert M. Allison, Jr., Assistant
Secretary for Financial Stability, U.S. Department of the
Treasury; Honorable William Apgar, Senior Advisor to the
Secretary for Mortgage Finance, U.S. Department of Housing and
Urban Development.
Panel 2: Ms. Joan Carty, President and CEO, The Housing
Development Fund in Bridgeport, CT; Ms. Mary Coffin, Head of
Mortgage Servicing, Wells Fargo; Ms. Diane E. Thompson, Of
Counsel, National Consumer Law Center; Mr. Allen Jones, Default
Management Executive, Bank of America Home Loans; Mr. Curtis
Glovier, Managing Director, Fortress Investment Group; Mr. Paul
S. Willen, Senior Economist and Policy Advisor, Federal Reserve
Bank of Boston; Mr. Thomas Perretta, Consumer, State of
Connecticut.
Establishing a Framework for Systemic Risk Regulation
Thursday, July 23, 2009
Witnesses
Panel 1: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Honorable Mary Schapiro, Chairman, U.S.
Securities and Exchange Commission; Honorable Daniel K.
Tarullo, Member, Board of Governors of the Federal Reserve
System.
Panel 2: Ms. Alice Rivlin, Senior Fellow, Economic Studies,
Brookings Institution; Dr. Allan H. Meltzer, Professor of
Political Economy, Tepper School of Business, Carnegie Mellon
University; Mr. Vincent Reinhart, Resident Scholar, American
Enterprise Institute; Mr. Paul Schott Stevens, President and
CEO, Investment Company Institute.
Regulatory Modernization: Perspectives on Insurance
Tuesday, July 28, 2009
Witnesses: Mr. Travis B. Plunkett, Legislative Director,
Consumer Federation of America; Mr. Baird Webel, Specialist in
Financial Economics, Congressional Research Service; Professor
Hal Scott, Nomura Professor of International Financial Systems,
Harvard Law School; Professor Martin Grace, James S. Kemper
Professor of Risk Management, Department of Risk Management and
Insurance, Georgia State University.
Protecting Shareholders and Enhancing Public Confidence by
Improving Corporate Governance
Wednesday, July 29, 2009
Witnesses: Ms. Meredith B. Cross, Director of the Division
of Corporate Finance, U.S. Securities and Exchange Commission;
Professor John C. Coates IV, John F. Cogan, Jr. Professor of
Law and Economics, Harvard Law School; Ms. Ann Yerger,
Executive Director, Council of Institutional Investors; Mr.
John J. Castellani, President, The Business Roundtable;
Professor J.W. Verret, Assistant Professor of Law, George Mason
University School of Law; Mr. Richard C. Ferlauto, Director of
Corporate Governance and Pension Investment, American
Federation of State, County and Municipal Employees.
Strengthening and Streamlining Prudential Bank Supervision
Tuesday, August 4, 2009
Witnesses
Panel 1: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Honorable John C. Dugan, Comptroller of
the Currency, Office of the Comptroller of the Currency;
Honorable Daniel K. Tarullo, Member, Board of Governors of the
Federal Reserve System; Mr. John Bowman, Acting Director,
Office of Thrift Supervision.
Panel 2: Honorable Eugene A. Ludwig, Chief Executive
Officer, Promontory Financial Group; Honorable Richard S.
Carnell, Associate Professor, Fordham University School of Law;
Honorable Martin N. Baily, Senior Fellow, Economic Studies, The
Brookings Institution.
Examining Proposals to Enhance the Regulation of Credit
Rating Agencies
Wednesday, August 5, 2009
Witnesses
Panel 1: Mr. Michael S. Barr, Assistant Secretary-Designate
for Financial Institutions, U.S. Department of the Treasury.
Panel 2: Professor John C. Coffee, Jr., Adolf A. Berle
Professor of Law, Columbia University Law School; Dr. Lawrence
J. White, Leonard E. Imperatore Professor of Economics, New
York University; Mr. Stephen W. Joynt, President and Chief
Executive Officer, Fitch Ratings; Mr. James Gellert, President
and CEO, Rapid Ratings; Mr. Mark Froeba, Principal, PF2
Securities Evaluations, Inc.
Alleged Stanford Financial Group Fraud: Regulatory and
Oversight Concerns and the Need for Reform
Monday, August 17, 2009
Witnesses
Panel 1: Mr. Craig Nelson, Investor, Stanford Securities,
Alabama; Mr. Troy Lillie, Investor, Stanford Securities,
Louisiana; Ms. Leyla Wydler, Former Vice President and
Financial Advisor, Stanford Financial Group; Professor Onnig
Dombalagian, George Denegre Professor of Law, Tulane University
Law School.
Panel 2: Ms. Rose Romero, Regional Director, U.S.
Securities and Exchange Commission; Mr. Daniel M. Sibears,
Executive Vice President, Member Regulation Programs, Financial
Industry Regulatory Authority (FINRA).
Oversight of the SEC's Failure to Identify the Bernard L.
Madoff Ponzi Scheme and How to Improve SEC Performance
Thursday, September 10, 2009
Witnesses
Panel 1: H. David Kotz, Esq., Inspector General, U.S.
Securities and Exchange Commission.
Panel 2: Mr. Harry Markopolos, Chartered Financial Analyst
and Certified Fraud Examiner; Robert Khuzami, Esq., Director,
Division of Enforcement, U.S. Securities and Exchange
Commission; John Walsh, Esq., Acting Director, Office of
Compliance Inspections and Examinations, U.S. Securities and
Exchange Commission.
Helping Homeowners Avoid Foreclosure
Monday, September 21, 2009
Witnesses
Panel 1: Honorable Shaun Donovan, Secretary, U.S.
Department of Housing and Urban Development.
Panel 2: Honorable Anne Milgram, Attorney General of New
Jersey; Ms. Marge Della Vecchia, Executive Director, New Jersey
Housing and Mortgage Finance Agency; Ms. Phyllis Salowe-Kaye,
Executive Director, New Jersey Citizen Action Board; Mr. Mario
Vargas, Executive Director, New Jersey Puerto Rican Action
Board; Mr. Edward Heaton, Homeowner from Springfield, New
Jersey; Mr. Bryan Bolton, Senior Vice President, Loss
Mitigation, CitiMortgage.
Emergency Economic Stabilization Act: One Year Later
Thursday, September 24, 2009
Witnesses
Panel 1: Honorable Herbert M. Allison, Jr., Assistant
Secretary for Financial Stability (TARP), U.S. Department of
the Treasury.
Panel 2: Honorable Neil M. Barofsky, Special Inspector
General, Troubled Asset Relief Program; Mr. Gene L. Dodaro,
Acting Comptroller General, United States Government
Accountability Office; Professor Elizabeth Warren, Chair,
Congressional Oversight Panel for the Troubled Asset Relief
Program.
Strengthening and Streamlining Prudential Bank Supervision
Tuesday, September 29, 2009
Witnesses: Honorable Eugene A. Ludwig, Chief Executive
Officer, Promontory Financial Group; Honorable Martin N. Baily,
Senior Fellow, Economic Studies, The Brookings Institution;
Honorable Richard S. Carnell, Associate Professor, Fordham
University School of Law; Mr. Richard Hillman, Managing
Director, Financial Markets and Community Investment, U.S.
Government Accountability Office.
International Cooperation to Modernize Financial Regulation
Wednesday, September 30, 2009
Witnesses: Ms. Kathleen L. Casey, Commissioner, U.S.
Securities and Exchange Commission; Mr. Mark Sobel, Acting
Assistant Secretary for International Affairs, U.S. Department
of the Treasury; Honorable Daniel K. Tarullo, Member, Board of
Governors of the Federal Reserve System.
Securitization of Assets: Problems and Solutions
Wednesday, October 7, 2009
Witnesses: Professor Patricia McCoy, George J. & Helen M.
England Professor of Law, University of Connecticut School of
Law; Mr. George P. Miller, Executive Director, American
Securitization Forum; Mr. Andrew Davidson, President, Andrew
Davidson & Co.; Mr. J. Christopher Hoeffel, Executive Committee
Member, Commercial Mortgage Securities Association; Dr. William
Irving, Portfolio Manager, Fidelity Investments.
Future of the Mortgage Market and the Housing Enterprises
Thursday, October 8, 2009
Witnesses
Panel 1: Mr. Edward J. DeMarco, Acting Director, Federal
Housing Finance Agency.
Panel 2: Mr. William Shear, Director, Financial Markets and
Community Investment, U.S. Government Accountability Office;
Mr. Andrew Jakabovics, Associate Director for Housing and
Economics, Center for American Progress Action Fund; Dr. Susan
M. Wachter, Worley Professor of Financial Management, Wharton
School of Business, University of Pennsylvania; Honorable Peter
Wallison, Arthur F. Burns Fellow in Financial Policy Studies,
American Enterprise Institute.
Restoring Credit to Manufacturers
Friday, October 9, 2009
Witnesses: Mr. David Andrea, Vice President, Industry
Analysis and Economics, Motor and Equipment Manufacturers
Association; Mr. Robert C. Kiener, Director of Member Outreach,
Precision Machined Products Association; Mr. Stephen P. Wilson,
Chairman and CEO, LCNB National Bank.
Examining the State of the Banking Industry
Wednesday, October 14, 2009
Witnesses: Honorable Sheila Bair, Chairman, Federal Deposit
Insurance Corporation; Honorable John C. Dugan, Comptroller of
the Currency, Office of the Comptroller of the Currency;
Honorable Daniel K. Tarullo, Member, Board of Governors of the
Federal Reserve System; Honorable Deborah Matz, Chairman,
National Credit Union Administration; Mr. Timothy T. Ward,
Deputy Director, Examinations, Supervision, and Consumer
Protection, Office of Thrift Supervision; Mr. Joseph A. Smith,
North Carolina Commissioner of Banks and Chairman, Conference
of State Bank Supervisors; Mr. Thomas J. Candon, Deputy
Commissioner, Vermont Department of Banking, Insurance,
Securities and Health Care Administration, National Association
of State Credit Union Supervisors.
The State of the Nation's Housing Market
Tuesday, October 20, 2009
Witnesses
Panel 1: Honorable Johnny Isakson (R-GA).
Panel 2: Honorable Shaun Donovan, Secretary, U.S.
Department of Housing and Urban Development.
Panel 3: Ms. Diane Randall, Executive Director, Partnership
for Strong Communities; Mr. Ronald Phipps, First Vice
President, National Association of Realtors; Mr. Emile J.
Brinkmann, Chief Economist and Senior Vice President for
Research and Economics, Mortgage Bankers Association; Mr. David
Crowe, Chief Economist, National Association of Home Builders.
Dark Pools, Flash Orders, High Frequency Trading, and Other
Market Structure Issues
Wednesday, October 28, 2009
Witnesses
Panel 1: Honorable Edward Kaufman, United States Senator.
Panel 2: James A. Brigagliano, Esq., Co-Acting Director of
the Division of Trading and Markets, U.S. Securities and
Exchange Commission; Mr. Frank Hatheway, Senior Vice President
and Chief Economist, NASDAQ OMX; William O'Brien, Esq., Chief
Executive Officer, Direct Edge; Mr. Christopher Nagy, Managing
Director of Order Routing Sales & Strategy, Ameritrade; Mr.
Daniel Mathisson, Managing Director and Head of Advanced
Execution Services, Credit Suisse; Mr. Robert C. Gasser,
President and Chief Executive Officer, Investment Technology
Group; Mr. Peter Driscoll, Chairman, Security Traders
Association; Mr. Adam C. Sussman, Director of Research, TABB
Group.
Protecting Consumers from Abusive Overdraft Fees: The
Fairness and Accountability in Receiving Overdraft Coverage Act
Tuesday, November 17, 2009
Witnesses: Mr. Mario Livieri, Consumer, State of
Connecticut; Mr. Michael D. Calhoun, President, Center For
Responsible Lending; Mr. Frank Pollack, President and CEO,
Pentagon Federal Credit Union; Mr. John Carey, Chief
Administrative Officer, Citibank NA; Ms. Jean Ann Fox, Director
of Financial Services, Consumer Federation of America.
Hearing on the nomination of The Honorable Ben S. Bernanke
Thursday, December 3, 2009
Witnesses: The Honorable Ben S. Bernanke, Chairman, Board
of Governors of the Federal Reserve System.
Prohibiting Certain High-Risk Investment Activities by
Banks and Bank Holding Companies
Tuesday, February 2, 2010
Witnesses: Honorable Paul Volcker, Chairman, President's
Economic Recovery Advisory Board; Honorable Neal S. Wolin,
Deputy Secretary, U.S. Department of the Treasury.
Implications of the `Volcker Rules' for Financial Stability
Thursday, February 4, 2010
Witnesses: Mr. Gerald Corrigan, Managing Director, Goldman
Sachs; Professor Simon Johnson, Ronald A. Kurtz Professor of
Entrepreneurship, Sloan School of Management, Massachusetts
Institute of Technology; Mr. John Reed, Retired Chairman,
Citigroup; Professor Hal Scott, Nomura Professor of
International Financial Systems, Harvard Law School; Mr. Barry
L. Zubrow, Executive Vice President, Chief Risk Officer,
JPMorgan Chase.
Equipping Financial Regulators with the Tools Necessary to
Monitor Systemic Risk
Friday, February 12, 2010
Witnesses
Panel 1: Honorable Daniel K. Tarullo, Member, Board of
Governors of the Federal Reserve System.
Panel 2: Honorable Allan I. Mendelowitz, Founding Member,
Committee to Establish the National Institute of Finance;
Professor John C. Liechty, Associate Professor of Marketing and
Statistics, Smeal College of Business, Pennsylvania State
University; Professor Robert Engle, Stern School of Business,
New York University; Mr. Stephen C. Horne, Vice President,
Master Data Management and Integration Services, Dow Jones
Business & Relationship Intelligence.
Restoring Credit to Main Street: Proposals to Fix Small
Business Borrowing and Lending Problems
Tuesday, March 2, 2010
Witnesses
Panel 1: Honorable Carl Levin (D-MI), United States
Senator; Honorable Debbie Stabenow (D-MI), United States
Senator.
Panel 2: Mr. Arthur Johnson, Chairman and CEO, United Bank
of Michigan, Grand Rapids, MI on behalf of the American Bankers
Association; Mr. Eric Gillett, Vice Chairman and CEO, Sutton
Bank, Attica, OH on behalf of the Independent Community Bankers
Association; Mr. Raj Date, Executive Director, Cambridge Winter
Center for Financial Institutions Policy.
VII. COMMITTEE CONSIDERATION
The Committee on Banking, Housing, and Urban Affairs met in
open session on March 22, 2010, and by a vote of 13-10 ordered
the bill reported, as amended.
VIII. CONGRESSIONAL BUDGET OFFICE COST ESTIMATE
Section 11(b) of the Standing Rules of the Senate, and
Section 403 of the Congressional Budget Impoundment and Control
Act, require that each committee report on a bill contain a
statement estimating the cost and regulatory impact of the
proposed legislation. The Congressional Budget Office has
provided the following cost estimate.
S. 3217--Restoring American Financial Stability Act of 2010
Summary: S. 3217 would grant new federal regulatory powers
and reassign existing regulatory authority among federal
agencies with the aim of reducing the likelihood and severity
of financial crises.
The legislation would establish a program to facilitate the
resolution of large financial institutions that become
insolvent or are in danger of becoming insolvent when their
failure is determined to threaten the stability of the nation's
financial system (such institutions are known as systemically
important firms). The program would be funded by fees assessed
on certain large financial companies; an Orderly Liquidation
Fund (OLF) of $50 billion would be accumulated, and in the
event of a costly resolution, the fund would be replenished
over time with future assessments.
A second new program would expand the authority of the
Federal Deposit Insurance Corporation (FDIC) to provide
government guarantees on a broad array of financial obligations
of banks and bank holding companies if federal officials
determine that market conditions are impeding the normal
provision of financing to creditworthy borrowers (known as a
liquidity crisis). Under the bill, participants in the program
would be charged fees designed to recover the costs of the
government guarantees.
Other provisions of S. 3217 would change how financial
institutions and securities markets are regulated, create a new
Bureau of Consumer Financial Protection (BCFP), broaden the
authority of the Commodity Futures Trading Commission (CFTC)
and the Securities and Exchange Commission (SEC), establish a
grant program to encourage the use of traditional banking
services, expand the supervision of firms that settle payments
between financial institutions, and make many other changes to
current laws.
Under the legislation, as under current law, there is some
probability that, at some point in the future, large financial
firms will become insolvent and liquidity crises will arise,
and that those financial problems will present significant
risks to the nation's broader economy. The cost of addressing
those problems under current law is unknown and would depend on
how the Administration and the Congress chose to proceed when
faced with financial crises in the future; they could, for
example, change laws, create new programs, appropriate
additional funds, and assess new fees. Depending on the
effectiveness of the new regulatory initiatives and new
authorities to resolve and support a broad variety of financial
institutions contained in S. 3217, enacting this legislation
could change the timing, severity, and federal cost of averting
and resolving future financial crises. However, CBO has not
determined whether the estimated costs under the bill would be
smaller or larger than the costs of alternative approaches to
addressing future financial crises and the risks they pose to
the economy as a whole.
Estimated Federal Budgetary Impacts
CBO estimates that enacting S. 3217 would increase revenues
by $32.4 billion over the 2011-2015 period and by $75.4 billion
over the 2011-2020 period and increase direct spending by $25.8
billion and $54.4 billion, respectively, over the same periods.
In total, CBO estimates those changes would decrease budget
deficits by $6.6 billion over the 2011-2015 period and by $21.0
billion over the 2011-2020 period. In addition, CBO estimates
that implementing the bill would increase spending subject to
appropriation by $4.6 billion over the 2011-2015 period and
$13.2 billion over the 2011-2020 period. Because enacting the
legislation would affect direct spending and revenues, pay-as-
you-go procedures apply.
Under S. 3217, the estimated reduction in budget deficits
over the 2011-2020 period stems largely from industry
assessments required to capitalize the OLF established by the
bill to resolve systemically important firms. Those collections
exceed the expected cost of liquidations during the
capitalization period. After that time, a growing share of the
budgetary resources for future liquidation activities would be
derived from interest credited on balances in the OLF (with
additional assessments collected only as needed to cover
losses). Such intragovernmental interest payments are not
budgetary receipts and do not affect the federal deficit. Thus,
CBO estimates that the expenses of the OLF would ultimately
exceed income from new assessments paid by financial firms,
resulting in an increase in the deficit in those later years.
Pursuant to section 311 of the Concurrent Resolution on the
Budget for Fiscal Year 2009 (S. Con Res. 70), CBO estimates
that the bill would increase projected deficits by more than $5
billion in at least one of the four consecutive 10-year periods
starting in 2021.
Mandates
The bill would impose intergovernmental and private-sector
mandates, as defined in the Unfunded Mandates Reform Act
(UMRA), on banks and other private and public entities that
participate in financial markets. The bill also would impose
intergovernmental mandates by prohibiting states from taxing
and regulating certain insurance products issued by companies
based in other states and by preempting certain state laws.
Because the costs of complying with some of the mandates would
depend on future regulations that would be established under
the bill, and because CBO has limited information about the
extent to which public entities enter into swaps with
unregulated entities, CBO cannot determine whether the
aggregate costs of the intergovernmental mandates would exceed
the annual threshold established in UMRA ($70 million in 2010,
adjusted annually for inflation). However, CBO estimates that
the cost of the mandates on private-sector entities would well
exceed the annual threshold established in UMRA for such
mandates ($141 million in 2010, adjusted annually for
inflation) because the amount of fees collected would be more
than that amount.
Page Reference Guide:
Sections
Major Provisions
Estimated Costs to the Federal Government
Basis of Estimate: Changes in Direct Spending and Revenues;
Changes in Spending Subject to Appropriation
Pay-As-You-Go Considerations
Intergovernmental and Private-Sector Impact
Abbreviations used in the cost estimate:
BCFP--Bureau of Consumer Financial Protection
CFTC--Commodity Futures Trading Commission
DIF--Deposit Insurance Fund
FDIC--Federal Deposit Insurance Corporation
FSOC--Financial Stability Oversight Council
GAO--Government Accountability Office
OCC--Office of the Comptroller of the Currency
OFR--Office of Financial Research
OLF--Orderly Liquidation Fund
OTS--Office of Thrift Supervision
PCAOB--Public Company Accounting Oversight Board
SEC--Securities and Exchange Commission
SIPC--Securities Investor Protection Corporation
Major provisions:
Title I would establish the Financial Stability Oversight
Council and the Office of Financial Research (OFR), both of
which would be funded by assessments on certain financial and
nonfinancial entities starting two years after the bill's
enactment. For the first two years after enactment, the Federal
Reserve would fund those activities.
Title II would establish a new program for resolving
certain financial firms that are insolvent or in danger of
becoming insolvent. The bill would create a fund, the OLF, from
which the costs of liquidation would be paid. The FDIC would be
directed to assess fees on private firms to build a $50 billion
balance in the OLF within 10 years of the bill's enactment.
Title III would abolish the Office of Thrift Supervision
(OTS) and change the regulatory oversight of banks, thrifts,
and related holding companies by transferring authorities and
employees among the remaining regulatory agencies.
Titles IV, VII, and IX would change and broaden the
authority of the SEC to oversee activities and entities
associated with the national securities exchanges.
Title V would establish an Office of National Insurance and
set national standards for how states may regulate and collect
taxes for a type of insurance that covers unique or atypical
risks--known as ``surplus lines'' or ``nonadmitted insurance.''
The bill also would establish national standards for how states
regulate reinsurance--often referred to as insurance for
insurance companies.
Titles VI would modify the regulation of bank, thrift, and
securities holding companies.
Title VII would change and broaden the authority of the
CFTC to regulate certain derivatives transactions on over-the-
counter markets.
Title VIII would broaden the supervision of certain firms
that settle payments between financial institutions.
Title X would establish the BCFP as an independent agency
within the Federal Reserve to enforce federal laws that affect
how banks and nonfinancial institutions make financial products
available to consumers for their personal use. The BCFP would
be funded by transfers from the Federal Reserve.
Title XI would establish a program to guarantee obligations
of certain financial entities when federal officials determine
that the economy faces a liquidity crisis. This title also
would make changes to certain lending activities of the Federal
Reserve.
Title XII would establish several grant programs to
encourage certain individuals to increase their use of the
federally insured banking system and community-based financial
institutions.
Estimated cost to the Federal Government: The estimated
budgetary impact of S. 3217 is shown in the following table.
The cost of this legislation fall within budget functions 370
(commerce and housing credit), 450 (community and regional
development), and 800 (general government).
TABLE 1.--ESTIMATED BUDGETARY IMPACT OF S. 3217, THE RESTORING AMERICAN FINANCIAL STABILITY ACT OF 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
By fiscal year, in billions of dollars--
-----------------------------------------------------------------------------------------------------
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011-2015 2011-2020
--------------------------------------------------------------------------------------------------------------------------------------------------------
CHANGES IN DIRECT SPENDINGEstimated Budget Authority........................ 4.0 6.3 5.6 5.1 5.4 5.6 5.5 5.3 5.8 6.5 26.4 55.2
Estimated Outlays................................. 3.6 6.3 5.4 5.1 5.4 5.6 5.5 5.3 5.8 6.5 25.8 54.4 CHANGES IN REVENUES
Estimated Revenues................................ 1.8 6.4 7.9 8.0 8.3 8.5 8.8 8.9 8.7 8.1 32.4 75.4
NET CHANGES IN THE BUDGET DEFICIT FROM CHANGES IN DIRECT SPENDING AND REVENUES
Estimated Impact on Deficita...................... 1.8 -0.1 -2.6 -2.9 -2.9 -2.9 -3.3 -3.7 -2.9 -1.6 -6.6 -21.0 CHANGES IN SPENDING SUBJECT TO APPROPRIATIONEstimated Authorization Level..................... 0.7 0.7 0.9 1.0 1.2 1.3 1.5 1.7 1.9 2.2 4.4 13.1
Estimated Outlays................................. 0.8 0.7 0.9 1.0 1.2 1.3 1.5 1.7 1.9 2.2 4.6 13.2
--------------------------------------------------------------------------------------------------------------------------------------------------------
a Positive numbers indicate increases in deficits; negative numbers indicate decreases in deficits.
Basis of estimate: For this estimate, CBO assumes that S.
3217 will be enacted before the end of fiscal year 2010, that
the necessary amounts will be appropriated in each year, and
that spending will follow historical patterns for activities of
the FDIC, the Federal Reserve, and other agencies.
CBO estimates that the net decrease in the deficit as a
result of the changes in revenues and direct spending would
total $21.0 billion over the 2011-2020 period. Most of that
amount, about $17.6 billion, would be generated by the
assessments to build up the OLF and the spending of a portion
of those funds.
About $4.9 billion of the net deficit decrease related to
changes in direct spending and revenues would result from
providing the SEC permanent authority to collect and spend
certain fees and reclassifying discretionary spending and
offsetting collections for the SEC as direct spending and
revenues. Revenues from the fees would exceed the SEC's
outlays. (Under current law, the SEC's authority to collect and
spend fees is provided in annual appropriation acts; fee
collections are recorded as offsetting collections, that is, a
credit against the agency's spending). Fees collected by the
SEC have historically exceeded the agency's spending; those
excess collections currently offset discretionary spending in
other areas of the budget. Consequently, changing the budgetary
treatment of the SEC's spending and receipts would increase
discretionary spending by removing that offset. CBO estimates
that such spending would increase by about $11.8 billion over
the 2011-2020 period. The $4.9 billion in net savings from the
change in direct spending and revenues would be less than the
increase in discretionary outlays because the SEC fees under S.
3217 would be lower than those projected under current law.
Changes in Direct Spending and Revenues
CBO estimates that enacting the legislation would increase
revenues by $75.4 billion over the 2011-2020 period (see Table
2). About $43.9 billion of those revenues would be generated by
assessments imposed by the FDIC, with the remainder arising
from other activities under the bill. Specifically:
Several provisions of the bill, most importantly
those establishing the BCFP and reassigning supervisory
responsibilities over financial institutions among the various
regulators, would increase the net earnings of the Federal
Reserve, which are recorded in the budget as revenues.
Reclassification of fees collected by the SEC also
would increase revenues, as would additional fees collected by
the Public Company Accounting Oversight Board (PCAOB) and the
Securities Investor Protection Corporation (SIPC).
CBO estimates that enacting the legislation would increase
direct spending by $54.4 billion over the 2011-2020 period (see
Table 2). About $19.4 billion of that amount would result from
allowing the SEC to spend certain fees without annual
appropriation action. Additional costs would be incurred by
establishing the BCFP, the Financial Stability Oversight
Council, and the OFR; broadening the regulatory duties of the
PCAOB; increasing the amount the SIPC may borrow from the
Treasury; authorizing the FDIC to provide loan guarantees to
financial institutions; and creating a program to make awards
to individuals providing certain information to the SEC.
TABLE 2.--NET CHANGES IN THE BUDGET DEFICIT FROM CHANGES IN DIRECT SPENDING AND REVENUES UNDER THE RESTORING AMERICAN FINANCIAL STABILITY ACT OF 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
By fiscal year, in billions of dollars--
-----------------------------------------------------------------------------------------------------
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011-2015 2011-2020
--------------------------------------------------------------------------------------------------------------------------------------------------------
NET CHANGES IN THE BUDGET DEFICIT FROM CHANGES IN DIRECT SPENDING AND REVENUESaOrderly Liquidation Authority..................... 2.4 0.2 -2.1 -2.8 -2.7 -2.6 -2.9 -3.3 -2.5 -1.2 -5.0 -17.6
Securities and Exchange Commission Regulation..... -0.7 -0.5 -0.4 -0.4 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -2.5 -4.9
Consumer Financial Protection..................... * 0.1 0.1 0.4 0.4 0.4 0.4 0.4 0.4 0.5 1.0 3.2
Emergency Financial Stability..................... * 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.4 0.8
Changes Among Financial Regulators................ * -0.2 -0.4 -0.5 -0.5 -0.5 -0.5 -0.6 -0.6 -0.6 -1.5 -4.3
Other Financial Oversight and Protection.......... * 0.1 0.1 0.2 0.2 0.2 0.1 0.1 0.1 0.1 0.7 1.3
Financial Stability Oversight..................... * * * 0.1 0.1 * * * * * 0.3 0.4
Other Provisions Affecting the Federal Reserve.... * * * * * * * * * * * 0.1
Total Net Change in the Budget Deficit........ 1.8 -0.1 -2.6 -2.9 -2.9 -2.9 -3.3 -3.7 -2.9 -1.6 -6.6 -21.0 CHANGES IN REVENUESOrderly Liquidation Authorityb.................... 0 4.2 5.2 5.1 5.2 5.2 5.2 5.1 4.8 4.0 19.7 43.9
Securities and Exchange Commission Regulation..... 1.8 1.9 2.1 2.2 2.3 2.5 2.7 2.9 2.9 3.0 10.3 24.4
Consumer Financial Protection..................... 0 0 0.1 0.1 0.1 0.2 0.2 0.2 0.2 0.2 0.4 1.2
Changes Among Financial Regulators................ 0 0.2 0.5 0.5 0.5 0.5 0.6 0.6 0.6 0.6 1.7 4.6
Other Financial Oversight and Protection.......... 0 * * * * 0.1 0.1 0.2 0.2 0.2 0.1 0.8
Financial Stability Oversight..................... 0 0 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.5
Other Provisions Affecting the Federal Reserve.... * * * * * * * * * * * -0.1
Total Revenues................................ 1.8 6.4 7.9 8.0 8.3 8.5 8.8 8.9 8.7 8.1 32.4 75.4 CHANGES IN DIRECT SPENDINGOrderly Liquidation Authority:
Estimated Budget Authority.................... 2.4 4.4 3.1 2.3 2.4 2.5 2.2 1.8 2.3 2.9 14.6 26.3
Estimated Outlays............................. 2.4 4.4 3.1 2.3 2.4 2.5 2.2 1.8 2.3 2.9 14.6 26.3
Securities and Exchange Commission Regulation:
Estimated Budget Authority.................... 1.5 1.5 1.7 1.8 1.9 2.1 2.3 2.4 2.5 2.5 8.3 20.1
Estimated Outlays............................. 1.1 1.5 1.6 1.7 1.9 2.0 2.2 2.4 2.5 2.5 7.8 19.4
Consumer Financial Protection:
Estimated Budget Authority.................... 0.1 0.1 0.3 0.6 0.6 0.6 0.6 0.6 0.6 0.6 1.5 4.6
Estimated Outlays............................. * 0.1 0.2 0.5 0.6 0.6 0.6 0.6 0.6 0.6 1.4 4.5
Emergency Financial Stability:
Estimated Budget Authority.................... * 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.4 0.8
Estimated Outlays............................. * 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.4 0.8
Changes Among Financial Regulators:
Estimated Budget Authority.................... * 0.1 0.1 * * * * * * * 0.2 0.3
Estimated Outlays............................. * 0.1 0.1 * * * * * * * 0.2 0.3
Other Financial Oversight and Protection:
Estimated Budget Authority.................... * 0.1 0.1 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.8 2.2
Estimated Outlays............................. * 0.1 0.1 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.8 2.2
Financial Stability Oversight:
Estimated Budget Authority.................... * 0.1 0.3 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.5 0.9
Estimated Outlays............................. * * 0.1 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.5 0.9
Total Changes in Direct Spending:
Estimated Budget Authority................ 4.0 6.3 5.6 5.1 5.4 5.6 5.5 5.3 5.8 6.5 26.4 55.2
Estimated Outlays......................... 3.6 6.3 5.4 5.1 5.4 5.6 5.5 5.3 5.8 6.5 25.8 54.4
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aPositive numbers indicate increases in deficits; negative numbers indicate decreases in deficits.
bThe legislation could affect federal tax receipts under the Internal Revenue Code. However, there are a number of uncertainties regarding potential
effects of the use of a bridge financial company by the Federal Deposit Insurance Corporation on the tax attributes of a failed financial institution.
It is not possible to determine whether the use of a bridge financial company would provide a tax result that is more or less favorable than
bankruptcy, which is the current-law alternative. Therefore, the staff of the Joint Committee on Taxation is not currently able to estimate the
changes in tax revenue that would result from this provision of the bill.
Note--* = between -$50 million and $50 million. Components may not sum to totals because of rounding.
Orderly Liquidation Authority
Title II would create new government mechanisms for
liquidating systemically important financial firms that are in
default or in danger of default. CBO estimates that
implementing those provisions would, on balance, reduce the
deficit by $17.6 billion over the 2011-2020 period.
Under conditions outlined in the bill, the FDIC would be
authorized to enter into various arrangements necessary to
liquidate such firms, including organizing bridge banks that
would be exempt from federal and state taxation. Funding for
those transactions would come from an Orderly Liquidation Fund
(OLF) established by the legislation and built up from
compulsory assessments paid by private firms (which would be
classified as revenues) and interest earned on fund balances
(which would be invested in Treasury securities). If fund
balances were insufficient to finance transactions that the
FDIC deemed appropriate, necessary amounts would be borrowed
from the Treasury up to a specified amount. Amounts borrowed
would be based on a formula tied to the value of the assets of
the liquidated firms and would be repaid through future
assessments.
The bill would direct the FDIC to assess upfront fees
sufficient to establish the OLF at the level of $50 billion
within 10 years after enactment but would allow the agency to
extend that deadline if any losses to the fund are incurred
during that period. The size of the fund would be adjusted
periodically for inflation.
CBO's estimate of the cost of the resolution authorities
provided under the bill represents the difference between the
expected values of spending by the OLF to resolve insolvent
firms and assessments collected by the OLF. Those expected
values represent a weighted average of various scenarios
regarding the potential frequency and magnitude of systemic
financial problems. Although the estimate reflects CBO's best
judgment on the basis of historical experience, the cost of the
program would depend on future economic and financial events
that are inherently unpredictable. Moreover, the timing of the
cash flows associated with resolving insolvent firms is also
difficult to predict. It might take several years, for example,
to replenish the funds spent to liquidate a complex financial
institution. As a result, some of the proceeds from asset sales
or cost-recovery fees related to financial problems emerging in
any 10-year period might be collected beyond that period. All
told, actual spending and assessments in each year would
probably vary significantly from the estimated amounts--either
higher or lower than the expected-value estimate provided for
each year.
Although the probability that the federal government would
have to liquidate a financial institution in any year is small,
the potential costs of such a liquidation could be large.
Measured on an expected-value basis, CBO estimates that net
direct spending for potential liquidation activities, which
includes recoveries from the sale of assets acquired from
liquidated institutions but excludes revenues from assessments,
would be $26.3 billion through 2020. As a result, the expected
timeframe for fully capitalizing the fund is longer than 10
years. CBO's estimate of assessments reflects the effects of
the interest earnings of the OLF (an estimated $7 billion),
which would reduce the amount that firms would have to pay to
capitalize the fund, and assumes that the FDIC would adjust the
size of the fund every year to account for inflation. CBO
estimates that revenues from assessments paid to capitalize the
fund and cover any losses would total about $44 billion through
2020, net of effects on payroll and income taxes.\1\ Under
CBO's estimate, the OLF would have a balance of about $45
billion at the end of 2020, including the value of assets
acquired in the course of liquidating financial institutions.
---------------------------------------------------------------------------
\1\The total amount collected from assessments is estimated to be
about $58 billion through 2020. But such assessments would become an
additional business expense for companies required to pay them. Those
additional expenses would result in decreases in taxable income
somewhere in the economy, which would produce a loss of government
revenue from income and payroll taxes that would partially offset the
revenue collected from the assessment itself.
---------------------------------------------------------------------------
Securities and Exchange Commission Regulation
Titles IV, VII, and IX would change and expand the
regulatory activities of the SEC. The bill also would grant
that agency permanent authority to collect and spend certain
fees; under current law, this authority is provided in annual
appropriation acts. Based on information from the agency, CBO
estimates that enacting those provisions would increase direct
spending by $19.4 billion over the 2011-2020 period. Of that
amount, CBO estimates that $16.9 billion would support the
agency's current activities. The balance, $2.5 billion, would
be incurred to carry out the new and expanded authorities under
the bill. CBO estimates that enacting the provisions also would
increase revenues by $24.4 billion over the 2011-2020 period.
Taken together, CBO estimates that the provisions would
decrease deficits by $4.9 billion over the 2011-2020 period.
Most of that decrease in the deficit--about $4.3 billion--
would be from fees collected that would be unavailable to the
agency for spending. The reduction in budget deficits from
changes in direct spending and revenues would probably be
accompanied by increases in discretionary spending, as
discussed later in this estimate.
Reclassification of Fees. Under the bill, the SEC's
authority to collect fees would be permanent rather than being
provided through annual appropriation action as is the case
under current law. The bill would authorize the SEC to assess
fees for securities trading activities sufficient to cover the
agency's annual operating expenses, plus an additional amount
to maintain a reserve that would be limited to 25 percent of
the following year's budget. The bill also would authorize the
SEC to collect fees to register securities in amounts
sufficient to meet targets set in the legislation. Those
collections would be recorded in the budget as revenues;
amounts collected by the SEC that exceed annual spending limits
plus the reserve amount would not be available for the agency
to spend. CBO assumes that the agency would set fees at levels
sufficient to meet its budgetary, statutory, and reserve
requirements each year.
Additional Regulatory Authority. The bill also would
broaden the SEC's authority to regulate activities and entities
associated with the securities markets. Among other things, the
bill would require advisers to private funds and organizations
that trade in or facilitate certain derivatives transactions to
register with the SEC, and it would broaden the SEC's oversight
of credit rating agencies and advisers for municipal issues.
CBO estimates that those additional activities would cost about
$2.5 billion over the 10-year period. CBO estimates that more
than 800 staff positions would be added over several years to
meet the agency's additional regulatory authority (a 22-percent
increase over current staffing levels). This estimate assumes
that the SEC generally would follow its regular examination
cycle and established examination procedures for regulating
advisers to private funds.
Consumer Financial Protection
Title X would establish the Bureau of Consumer Financial
Protection as an autonomous entity within the Federal Reserve.
The bureau would enforce federal laws related to consumer
financial protection by establishing rules and issuing orders
and guidance. CBO estimates that creating the BCFP would
increase budget deficits by $3.2 billion over the 2011-2020
period.
The bureau would be authorized to:
Examine and regulate insured depository
institutions and credit unions with more than $10
billion in assets;
Request reports from insured depository
institutions and credit unions with $10 billion in
assets or less, and participate in the examinations
performed by the regulators of those institutions; and
Supervise large nondepository institutions,
mortgage lenders, brokers, and financial service
providers.
The bureau would coordinate examinations with other federal
or state regulators of the institutions. Similar functions and
the personnel who now perform those duties at federal agencies
and the Federal Reserve would be transferred to the new bureau.
The bill would require the Board of Governors of the
Federal Reserve to fund the BCFP through transfers from the
earnings of the Federal Reserve. The amounts transferred would
be limited to a percentage, starting at 10 percent in 2011 and
increasing to 12 percent in 2013 and thereafter, of the 2009
total operating expenses of the Federal Reserve, adjusted
annually for inflation. In CBO's judgment, the costs of the
BCFP should be reported as expenditures in the federal budget
(rather than a reduction in revenues) because the BCFP would be
independent of the Federal Reserve and its activities would be
separate and distinct from the Federal Reserve's
responsibilities for monetary policy and financial regulation.
Therefore, CBO estimates that the provisions of title X would
increase direct spending by $4.5 billion over the 2011-2020
period. That estimate is based on the Federal Reserve's
reported 2008 operating expenses, the most recent information
available.
Based on information from the Federal Reserve, CBO
estimates that about 515 staff positions would be transferred
from the Federal Reserve to the BCFP to carry out the new
regulatory authorities. CBO estimates that this transfer of
staff would reduce the Federal Reserve's operating expenses by
$1.2 billion over the 2011-2020 period, increasing remittances
from the Federal Reserve to the Treasury (which are recorded in
the federal budget as revenues) by that amount.
Emergency Financial Stability
In 2008, the FDIC established a temporary program to
guarantee certain obligations of insured depository
institutions, holding companies that include insured depository
institutions, and some affiliates of those firms. (The program
remains open to some new participants, and significant
potential liabilities remain from existing participants.)
Participants pay an upfront fee set to offset expected losses,
and any shortfall will be recovered through an assessment on
all FDIC-insured institutions. Conversely, in the event that
any excess fees are collected, those amounts will revert to the
Deposit Insurance Fund (DIF) and may be spent or used to reduce
future deposit insurance premiums. The program provides two
types of guarantees: one program, which expires in December
2012, is for newly issued, senior unsecured debt, and the
other, which expires in December 2010, is for amounts in
certain non-interest-bearing accounts.
Title XI would provide a new statutory framework for
similar, but potentially much broader, assistance. Under the
bill, the FDIC would be authorized to establish a guarantee
program if the Federal Reserve, the Secretary of the Treasury,
and the FDIC determine that a liquidity crisis warrants use of
such authority. Although the types of firms eligible to
participate would be similar to those eligible under the
existing FDIC program, the bill would not limit the types or
duration of financial obligations that could be guaranteed.
Firms still would be required to pay an upfront fee for the
guarantees, but any shortfall would be recovered solely from
program participants rather than all FDIC-insured institutions.
In addition, any excess fees would be deposited in the U.S.
Treasury and would not be available to be spent.
CBO's estimate of the cost of those provisions reflects the
expected value of the costs of such guarantees relative to the
expected value of the costs that would be incurred under
current law. CBO expects that, in the absence of this
legislation, the FDIC would respond to any future liquidity
crises by implementing guarantee programs similar to those it
adopted in 2008. The costs of this program, like those that
would result from implementing the liquidation authorities in
title II, would depend on circumstances that are difficult to
predict. In addition, cash flows over the 10-year period would
depend, as for title II, on the lag between potential spending
for losses and the collection of fees to offset those costs.
Therefore, while this estimate reflects CBO's best judgment
regarding expected costs, the actual costs would probably vary
significantly from the amount estimated for any given year.
Based on historical experience, we expect that the
probability of systemic liquidity problems in any year is
small. In the event of liquidity crises, however, the
legislation would authorize the FDIC to take a broader range of
actions that could generate losses that would take some time to
recover. In particular, CBO expects that limiting the recourse
for cost-recovery fees to program participants would cause the
FDIC to recoup losses over a long period of time to avoid
placing large burdens on a small set of firms. Altogether, CBO
estimates that enacting those provisions would increase net
direct spending by $0.8 billion over the 2011-2020 period
relative to current law.
Changes Among Financial Regulators
Title III would change the regulatory regime for
supervising banks, thrifts, and related holding companies. It
would abolish the Office of Thrift Supervision (OTS) and reduce
the number of firms regulated by the Federal Reserve.
Supervision of firms with consolidated assets of less than $50
billion that currently are regulated by the OTS and the Federal
Reserve would be transferred to the Office of the Comptroller
of the Currency (OCC) or the FDIC, depending on each firm's
charter. The Federal Reserve would continue regulating bank
holding companies with assets totaling above $50 billion and
also would supervise thrift holding companies exceeding that
threshold. Other provisions would direct agencies to complete
the transition within 18 months after enactment; authorize
spending of unobligated balances held by the OTS for transition
and other costs; and allow the OCC to enter into agreements
without regard to existing laws governing the disposition of
real or personal property. Finally, the bill would require all
of those agencies, including the Federal Reserve, to charge
fees to cover supervisory expenses.
CBO estimates that implementing those provisions would
reduce the deficit by an estimated $4.3 billion over the next
10 years. CBO expects that changes in costs that would result
from transferring personnel among the banking agencies would
have no net budgetary impact because they would be offset by
corresponding changes in the amounts collected from regulated
institutions. The net budgetary impact of this title would
result from:
Collecting fees from firms currently
regulated by the Federal Reserve, which CBO estimates
would average about $500 million a year or a total of
$4.6 billion over the 2011-2020 period;
Spending of the unobligated balances held by
the OTS over the 2011-2020 period, which CBO estimates
would total about $150 million, net of certain existing
liabilities; and
Financing the acquisition of buildings and
other property for OCC operations, which CBO estimates
would result in a net increase in direct spending of
$150 million over the next 10 years.
This title would change direct spending and revenues
because of the way banking agencies are funded. Under current
law, costs incurred by the OCC, OTS, and FDIC are recorded in
the budget as direct spending and are offset by receipts from
annual fees or insurance premiums. The budgetary effects of the
Federal Reserve's activities are recorded as changes in
revenues (governmental receipts). After accounting for changes
in agency workloads and the implementation of new supervisory
fees, CBO estimates that most of the budgetary impact of those
changes would be recorded in the budget as an increase in
revenues.
Other Financial Oversight and Protections
The bill would change the authorities of the PCAOB and
SIPC, which provide oversight and various protections in the
financial markets. The bill also would establish a program to
give awards to individuals who provide information to the SEC
about violations of securities laws. CBO estimates that taken
together, those provisions would increase budget deficits by
$1.3 billion over the 2011-2020 period.
In particular, the bill would establish a whistleblower
program at the SEC that would award a portion of penalties
collected in certain proceedings brought for violation of
securities laws to individuals providing information leading to
the imposition of the penalties. Based on information from the
SEC, CBO estimates that this program would cost about $100
million per year once the regulations are in place. We estimate
that enacting the award program would increase direct spending
by $0.9 billion over the 2011-2020 period.
The bill would expand the authority of the PCAOB to oversee
the auditors of brokers and dealers that are registered with
the SEC; those provisions also would increase fees collected by
the PCAOB to support examination activities. Based on
information from the PCAOB, CBO estimates that the additional
oversight and examination requirements would increase the
agency's costs by about $25 million per year and that the
agency would increase fees charged to brokers and dealers to
cover those additional costs. CBO estimates that enacting the
PCAOB provisions would increase direct spending by $0.2 billion
over the 2011-2020 period and increase revenues, net of income
and payroll tax offsets, by a similar amount over the same
period. The net effect on the deficit as a result of the PCAOB
provisions would be less than $0.1 billion.
The bill would raise the amount that SIPC would be
authorized to borrow from the Treasury. Under current law, SIPC
makes payments from fee collections and reserves to investors
that are harmed when a brokerage firm fails and customers'
assets are missing. In the event collections and reserves are
insufficient to cover the losses, SIPC is authorized to borrow
up to $1 billion from the Treasury; the bill would raise that
borrowing limit to $2.5 billion. SIPC would repay any amounts
borrowed by raising fees paid by brokers and dealers that are
registered with the SEC; such fees are recorded in the budget
as revenues.
Based on information from SIPC, CBO estimates that the
agency would probably exercise some of the additional borrowing
authority provided in this title during the next 10 years. We
estimate that borrowing additional funds would increase direct
spending by about $1.0 billion over the 2011-2020 period.
Further, we estimate that SIPC would recover that cost by
raising fees, thus increasing revenues over the same period by
$0.7 billion; CBO estimates that the net effect of this
provision would be to raise budget deficits by $0.3 billion
over the 2011-2020 period.
Financial Stability Oversight
Title I would establish a new council and office in the
Department of the Treasury to oversee the financial markets.
The Financial Stability Oversight Council, led by the Secretary
of the Treasury, would be responsible for identifying risks to
the financial stability of the United States, facilitating
information sharing and setting oversight priorities among
regulators, and potentially directing the Federal Reserve to
supervise additional financial institutions that it does not
currently regulate. The council would rely upon the OFR, also
established in the bill, to collect information on financial
markets and to provide independent research.
Based on amounts spent by other councils and agencies that
provide similar levels of analysis and support, CBO estimates
that that those new functions would cost about $75 million
annually. We expect that the office would steadily expand its
staff and budget over a three- to four-year period before it
reached that level of effort. We estimate that those functions
would cost $0.3 billion over the 2011-2015 period and $0.7
billion over the 2011-2020 period.
Title I also would allow the OFR to enter into enhanced-use
lease arrangements with nonfederal partners to acquire new
facilities. Based on the experience of other agencies with
similar authorities, CBO expects that such leases would involve
significant federal commitments. We estimate that the OFR would
use its enhanced-use leasing authorities to build one general-
purpose office building at a net cost of $0.2 billion over the
2011-2015 and 2011-2020 periods. CBO expects that the remaining
construction costs would be covered by fee collections after
2020.
To fund the OFR and the council, the legislation would
establish a Financial Research Fund within the Treasury. For
the first two years after enactment, the costs of the council
and the OFR would be paid by the Federal Reserve. In CBO's
judgment, those costs should be recorded as expenditures in the
federal budget because, like the BCFP, the council and the OFR
would be independent of the Federal Reserve and their
activities would be distinct from the Federal Reserve's
responsibilities for monetary policy and financial regulation.
Starting in 2013, the Secretary of the Treasury would collect
an assessment from certain bank holding companies and nonbank
financial companies supervised by the Federal Reserve that
would be sufficient to cover the operating expenses of the OFR
and the council.
CBO estimates that collecting the assessment, net of income
and payroll tax offsets, would increase revenues by $0.2
billion over the 2011-2015 period and $0.5 billion over the
2011-2020 period. On balance, we estimate that enacting title I
would increase budget deficits by $0.3 billion over the 2011-
2015 period and $0.4 billion over the 2011-2020 period.
Other Provisions Affecting the Federal Reserve
CBO estimates that the requirements in a number of titles
would result in incremental costs to the Federal Reserve,
thereby reducing remittances to the Treasury (which are
recorded in the budget as revenues). Based on information from
the Federal Reserve, CBO estimates that those provisions would
reduce revenues by about $0.1 billion over the 2011-2020
period. CBO expects the costs under title I to occur only in
the first few years; in all other cases, the costs are expected
to be ongoing. The key provisions of this sort are:
The Chairman of the Board of Governors would be a
member of the Financial Stability Oversight Council, and
Federal Reserve staff could be assigned to support the work of
the council.
Under title VI, the Federal Reserve would incur
costs to supervise any qualifying securities holding companies
that elect to be supervised by the Federal Reserve.
Additionally, the Federal Reserve would develop, in conjunction
with other federal banking agencies, the regulations to
implement restrictions regarding investments by banking
organizations in private equity funds and hedge funds and the
proprietary trading activities of banking organizations.
Title VII would expand the rule-making
requirements for the Federal Reserve related to capital and
margin requirements for swap dealers and major swap
participants that are banks.
Title VIII would likely increase the workload of
the Federal Reserve to supervise systemically important
entities that are involved in settling payments between
financial institutions.
Changes in Spending Subject to Appropriation
CBO estimates that implementing the legislation would
increase spending subject to appropriation by about $4.6
billion over the 2011-2015 period (see Table 3). Most of this
additional spending would result from the proposed
reclassification of fees and spending by the SEC, leading to a
reduction in discretionary spending by the SEC and a greater
reduction in discretionary offsetting collections from SEC
fees.
Reclassification of SEC Fees and Spending
Enacting the bill would change the budgetary classification
of fees collected by the SEC from offsetting collections
(amounts netted against discretionary appropriations) to
revenues. In addition, because the legislation would authorize
the SEC to spend all the fees it collects without further
appropriation, the need to appropriate funds for the SEC's
operations would be eliminated. Historically, fees collected by
the SEC have exceeded the agency's authorized spending limits.
CBO estimates that the proposed reclassification of fees
and spending would reduce discretionary spending by $5.7
billion over the 2011-2015 period and reduce offsetting
collections by $9.6 billion over the same period. Taken
together, those reductions would increase net spending subject
to appropriation by about $4.0 billion over the 2011-2015
period and by $11.8 billion over the 2011-2020 period because
the reduction in amounts that offset spending would exceed the
reduction in authorized spending levels. (As described on page
10, the new permanent authority to levy fees and spend the
proceeds would decrease deficits by an estimated $2.5 billion
over the 2011-2015 period and by $4.9 billion over the 2011-
2020 period.)
TABLE 3.--CHANGES IN SPENDING SUBJECT TO APPROPRIATION UNDER THE RESTORING AMERICAN FINANCIAL STABILITY ACT OF
2010
----------------------------------------------------------------------------------------------------------------
By fiscal year in millions of dollars--
-----------------------------------------------------------------
2011 2012 2013 2014 2015 2011-2015
----------------------------------------------------------------------------------------------------------------
CHANGES IN SPENDING SUBJECT TO APPROPRIATION
Reclassification of SEC Fees and Spending:
Spending:
Estimated Authorization Level......... -1,117 -1,139 -1,167 -1,198 -1,233 -5,854
Estimated Outlays..................... -949 -1,136 -1,163 -1,193 -1,228 -5,669
Offsetting Collections:
Estimated Authorization Level......... 1,733 1,733 1,885 2,052 2,235 9,638
Estimated Outlays..................... 1,733 1,733 1,885 2,052 2,235 9,638
Total Reclassification of SEC Fees and
Spending:
Estimated Authorization Level..... 616 594 718 854 1,002 3,784
Estimated Outlays................. 784 597 722 859 1,007 3,969
Regulation of Over-the-Counter Derivatives:
Estimated Authorization Level............. 18 55 75 76 77 301
Estimated Outlays......................... 16 51 73 76 77 293
Access to Mainstream Financial Institutions:
Estimated Authorization Level............. 57 57 58 59 60 291
Estimated Outlays......................... 15 57 58 59 59 248
Federal Insurance Office:
Estimated Authorization Level............. 2 2 2 2 2 10
Estimated Outlays......................... 1 2 2 2 2 9
Grants to Prevent Misleading Marketing:
Authorization Level....................... 8 8 8 8 8 40
Estimated Outlays......................... 1 3 7 7 8 26
Reports:
Estimated Authorization Level............. 8 3 1 1 1 14
Estimated Outlays......................... 7 4 1 1 1 14
Total Changes:
Estimated Authorization Level......... 709 719 862 1,000 1,150 4,440
Estimated Outlays..................... 824 714 862 1,004 1,154 4,558
----------------------------------------------------------------------------------------------------------------
Note: Components may not sum to totals because of rounding
Regulation of Over-the-Counter Derivatives
Title VII would require certain derivatives transactions to
take place on registered exchanges and would place new
registration and reporting requirements on entities that trade
in or facilitate such transactions. This title would broaden
the authority of the CFTC to regulate entities and activities
related to those transactions.
Based on information from the CFTC, CBO estimates that
implementing those broader authorities would cost $293 million
over the 2011-2015 period, assuming appropriation of the
necessary amounts. CBO estimates that the agency would add 235
employees by fiscal year 2013 to write regulations and to
undertake the additional oversight and enforcement activities
required under the bill. That would amount to a roughly 40
percent increase over 2010 staffing levels.
Access to Mainstream Financial Institutions
Title XII would authorize the appropriation of such sums as
may be necessary to establish several programs aimed at
increasing access to and usage of traditional banking services
in lieu of alternative financial services such as nonbank money
orders and check cashing, rent-to-own agreements, and payday
lending. Based on pilot programs operated by the private sector
and information collected by the FDIC, CBO estimates that this
effort would cost $248 million over the 2011-2015 period,
assuming appropriation of the necessary amounts.
Federal Insurance Office
Title V would establish the Federal Insurance Office within
the Department of the Treasury to monitor the insurance
industry and to coordinate federal policy on insurance issues.
The bill also would authorize the Secretary of the Treasury to
enter into international agreements to harmonize regulations on
the insurance industry. Based on information from the Treasury,
CBO estimates that implementing those provisions would cost $9
million over the 2011-2015 period, subject to the appropriation
of the necessary amounts.
Grants To Prevent Misleading Marketing
Title IX would authorize the appropriation of $8 million in
each of fiscal years 2011 through 2015 for grants to states to
protect elderly citizens from misleading marketing of financial
products. CBO estimates that implementing this provision would
cost $26 million over the 2011-2015 period.
Reports
The bill would require the Government Accountability Office
(GAO) to prepare more than 20 reports on a wide range of
topics, including financial literacy, oversight of financial
planners, and disclosures by issuers of municipal securities.
The bill also would require GAO to audit the BCFP annually.
Based on information from the agency, CBO estimates that each
report would cost, on average, $500,000 and would be completed
within the time allotted in the bill. CBO estimates that
implementing the reporting provisions in the bill would cost
$14 million over the 2011-2015 period, assuming appropriation
of the necessary amounts.
Pay-as-you-go considerations: The Statutory Pay-As-You-Go
Act of 2010 establishes budget reporting and enforcement
procedures for legislation affecting direct spending or
revenues. The net changes in outlays and revenues that are
subject to those pay-as-you-go procedures are shown in the
following table.
CBO ESTIMATE OF PAY-AS-YOU-GO EFFECTS FOR S. 3217, THE RESTORING AMERICAN FINANCIAL STABILITY ACT OF 2010, AS ORDERED REPORTED BY THE SENATE COMMITTEE
ON BANKING, HOUSING, AND URBAN AFFAIRS ON MARCH 22, 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
By fiscal year, in billions of dollars--
----------------------------------------------------------------------------------------------------
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2011-2015 2011-2020
--------------------------------------------------------------------------------------------------------------------------------------------------------
NET INCREASE OR DECREASE (-) IN THE DEFICIT
Statutory Pay-as-You-Go Impacta.................... 1.8 -0.1 -2.6 -2.9 -2.9 -2.9 -3.3 -3.7 -2.9 -1.6 -6.6 -21.0
--------------------------------------------------------------------------------------------------------------------------------------------------------
aPositive numbers indicate increases in deficits; negative numbers indicate decreases in deficits.
Intergovernmental and private-sector impact: The bill would
impose intergovernmental and private-sector mandates, as
defined in UMRA, on banks and other private and public entities
that participate in financial markets. The bill also would
impose intergovernmental mandates by prohibiting states from
taxing and regulating certain insurance products issued by
companies based in other states and by preempting certain state
laws. Because the costs of complying with some of the mandates
would depend on future regulations that would be established
under the bill, and because CBO has limited information about
the extent to which public entities enter into swaps with
unregulated entities, CBO cannot determine whether the
aggregate costs of the intergovernmental mandates would exceed
the annual threshold established in UMRA ($70 million in 2010,
adjusted annually for inflation). However, CBO estimates that
the total amount of fees alone that would be collected from
private entities would well exceed the annual threshold
established in UMRA for private-sector mandates ($141 million
in 2010, adjusted annually for inflation).
Mandates That Apply to Both Intergovernmental and Private-Sector
Entities
Some mandates in the bill would affect both public and
private entities, including pension funds and public finance
authorities. The cost of complying with the mandates is
uncertain and would depend on the nature of future regulations
and the range of entities subject to them.
Consumer Financial Protection. The bill would authorize the
BCFP to regulate banks and credit unions with assets over $10
million, all mortgage-related businesses (housing finance
agencies, lenders, servicers, mortgage brokers, and foreclosure
operators), and all large nonbank financial companies (such as
payday lenders, debt collectors, and consumer reporting
agencies). The BCFP would enforce federal laws related to
consumer protection by establishing rules and issuing orders
and guidance. Bank and nonbank entities that offer financial
services or products would be required to make disclosures to
customers and submit information to the BCFP. The bill also
would require certain financial institutions to maintain
records regarding deposit accounts of customers and would
prohibit prepayment penalties for residential mortgage loans.
Regulation of Over-the-Counter Derivatives Markets. The
bill would impose several requirements on public and private
entities such as pension funds, swap dealers, and other
participants in derivatives markets. For example, the bill
would place new requirements on derivatives; require reporting
by entities that gather trading information about swaps,
organizations that clear derivatives, facilities that execute
swaps, pension funds, and swap dealers; and establish capital
requirements for pension funds, swap dealers and major swap
participants.
Regulation of Financial Securities. The bill would require
entities (including public finance authorities) that sell
products such as mortgage-backed securities to hold at least 5
percent of the credit risk of each asset that they securitize.
Under the bill, the BCFP could exempt classes of assets from
the retention requirement. The bill also would require issuers
of securities to disclose information to the SEC about the
underlying assets and to analyze the quality of those assets.
Mandates That Apply Only to Intergovernmental Entities
Prohibition on Investments by Small Public Entities. The
bill would impose a mandate on public entities that invest more
than $25 million but less than $50 million by prohibiting them
from entering into swaps with entities that are not federally
regulated.
The costs of complying with this mandate would be equal to
the difference between the cost of entering into a swap with an
unregulated entity and the cost of entering into one with a
regulated entity, but because CBO has limited information about
the extent to which public entities enter into such
arrangements, we have no basis for estimating the cost of
complying with this mandate.
Prohibition on Taxation of Surplus Lines. The bill would
establish national standards for how states may regulate,
collect, and allocate taxes for a type of insurance that covers
unique or atypical risks--known as surplus lines or nonadmitted
insurance. The bill also would establish national standards for
how states regulate reinsurance. As defined in UMRA, the direct
costs of a mandate include any amounts that state and local
governments would be prohibited from raising in revenues as a
result of the mandate. The direct costs of this mandate would
be the amount of taxes on premiums for surplus lines issued by
out-of-state brokers that states would be precluded from
collecting.
While there is some uncertainty surrounding the amount of
tax that states currently collect, the portion of the surplus
lines market that would be affected, and the flexibility
available to states after enactment of the bill, CBO estimates
that forgone revenues would total less than $50 million,
annually, beginning one year after enactment. For the purpose
of estimating the direct cost of the mandate, CBO considered
the taxes that the industry estimates it is paying and the
revenues that states, as a whole, would no longer be able to
collect as a result of the bill.
Prohibition on Fees for Licensing Brokers. The bill would
prohibit states from collecting licensing fees from brokers of
surplus lines unless states participate in a national database
of insurance brokers. CBO estimates that the costs of
participating in the database would be small.
Regulation of Reinsurance. The bill would prohibit states
other than the state where a reinsurer is incorporated and
licensed from regulating the financial solvency of that
reinsurer, if that state is accredited by the National
Association of Insurance Commissioners. The bill also would
limit the way states regulate insurers that purchase
reinsurance. Those mandates would impose no direct costs on
states.
Preemption of State Laws. The bill would preempt state laws
that affect the offer, sale, or distribution of swaps as well
as consumer protection and insurance laws. The preemptions
would be mandates as defined in UMRA, but they would impose no
duty on states that would result in additional spending.
Mandates That Apply Only to Private Entities
Orderly Liquidation Fund. Under the bill, the largest
financial companies would be required to pay assessments
totaling up to $50 billion into the OLF over the 10 years after
the bill's enactment. Those companies also would have to submit
plans to regulators for how they could be liquidated in the
event of a failure. Because of the target size of the fund, CBO
estimates that the cost of complying with the mandates would
greatly exceed the annual threshold for private-sector mandates
in each of the first five years the mandate is in effect.
Security and Exchange Commission Fees. The bill would
increase the amount of fees collected by the SEC, and such an
increase would impose a mandate on participants in securities
markets. The cost of the mandate would be the incremental
increase in such fees compared to current law. CBO estimates
that increase would total at least $650 million over the first
five years that the mandate is in effect.
Financial Stability Oversight. The Financial Stability
Oversight Council would have the authority to require the
Federal Reserve to supervise nonbank companies that may pose
risks to the financial stability of the United States. The
council also would have the authority to require a large bank
holding company that poses a risk to the financial stability of
the United States to meet certain conditions and to terminate
certain activities. In addition, the Federal Reserve would be
required to establish standards for nonbank financial companies
and large bank holding companies regarding capital and
liquidity requirements, leverage and concentration limits,
credit exposure, and remediation. The cost of complying with
these mandates is uncertain and would depend on the details of
future regulations.
Beginning two years after the bill's enactment, certain
bank holding companies and nonbank financial companies
supervised by the Federal Reserve would be required to pay an
assessment to the Secretary of the Treasury to cover the
operating expenses of the Council and the Office of Financial
Research. Based on information from the Treasury Department,
CBO estimates that the cost of complying with the mandate would
total about $70 million per year.
Regulation of Certain Financial Companies. The regulation
of some financial companies (including some banks, thrifts, and
related holding companies) would be transferred to different
federal agencies, including the OCC and the FDIC. Companies
that are currently regulated by the Federal Reserve would be
required to pay new fees and meet the requirements of their new
regulator. CBO estimates that the amount of additional fees
paid by those companies would amount to about $500 million per
year.
Federal regulators would be required to implement rules for
banks, their affiliates and bank holding companies, and other
financial companies to prohibit proprietary trading,
sponsoring, and investing in hedge funds and private equity
funds, and limiting relationships with hedge funds and private
equity funds. Because the requirements on such companies would
depend on future rules and regulations, CBO cannot estimate the
cost of complying with the mandates.
Companies supervised by the Federal Reserve also would be
prohibited from voting for directors of the Federal Reserve
Banks. CBO expects there would be no cost to comply with that
mandate.
Regulation of Financial Market Utilities. The legislation
would require persons who manage or carry out payment,
clearing, and settlement activities among financial
institutions to meet uniform standards that would be
established by the Federal Reserve regarding the management of
risks and clearing and settlement activities. The cost of
complying with the standards would depend on those future
regulations.
Office of National Insurance. The bill would require
insurance companies to provide data and information to the
Office of National Insurance, which would also have subpoena
authority. The cost of the mandates would be small.
Regulation of Securities Markets. The bill would broaden
the SEC's authority to regulate entities and activities
associated with securities markets.
Regulation of Advisers to Hedge Funds. The bill would
require hedge fund advisers that manage over $100 million in
assets to register with the SEC. According to industry experts,
the expenses for those advisers to prepare for the registration
process would probably average less than $30,000 per firm.
Based on information from the SEC regarding the number of firms
that could be affected by the requirement, CBO estimates that
the cost of the mandate would fall below the annual threshold
established in UMRA.
Mandatory Arbitration. The bill would authorize the SEC to
prohibit mandatory predispute arbitration agreements between
brokers, dealers, municipal financial advisers and their
clients. Based upon information from industry sources, CBO
expects that if the SEC were to impose such a mandate, the
incremental cost to those entities of using the court system
instead of arbitration could be significant.
Deficiencies in Regulation. The bill would require the SEC
to establish regulations to address any deficiencies it finds
in the regulation of brokers, dealers, and investment advisers.
The cost of the mandates, if any, would depend on future rules
and regulations.
Other Financial Oversight and Protections. The cost of each
of the following mandates on securities markets would be small,
relative to the annual threshold. The bill would:
Change the makeup of the Municipal
Securities Regulatory Board and require municipal
securities advisers to register with the SEC;
Require auditors of broker-dealers to
register with PCAOB and allow it to charge higher
regulatory fees;
Require members of a compensation committee
for companies that issue securities to be independent;
require companies to provide for an annual nonbinding
vote on executive pay and disclose to shareholder the
relationship between executive pay and performance; and
require companies to have a compliance officer;
Place additional requirements on the
election of directors to the board of a company; and
Require credit rating agencies to provide
public disclosures about methods used to determine
credit ratings and the performance of those ratings; to
meet education requirements for analysts; and to
institute policies to address conflicts of interest.
Previous CBO estimates: CBO has transmitted several cost
estimates for bills ordered reported by the House Committee on
Financial Services containing provisions that are similar to
provisions in the Restoring American Financial Stability Act of
2010. CBO also published estimates of the direct spending and
revenue effects of the Wall Street Reform and Consumer
Protection Act of 2009, which consolidated and amended the
individual bills and contained additional provisions.
On December 9, 2009, CBO transmitted an estimate for the
Wall Street Reform and Consumer Protection Act of 2009 as
ordered reported by the House Committee on Rules on December 8,
2009. Earlier, on December 4, 2009, CBO published an estimate
for the Wall Street Reform and Consumer Protection as
introduced on December 2, 2009.
On July 30, 2009, CBO transmitted an estimate for H.R.
3269, the Corporate and Financial Institution Compensation
Fairness Act of 2009, as ordered reported by the House
Committee on Financial Services on July 28, 2009. H.R. 3269
contains provisions that are similar to subtitle E of title IX
of the Restoring American Financial Stability Act.
On November 3, 2009, CBO transmitted an estimate for H.R.
3795, the Over-the-Counter Derivatives Markets Act of 2009, as
ordered reported by the House Committee on Financial Services
on October 15, 2009. On November 6, 2009, CBO transmitted an
estimate for H.R. 3795, the Derivatives Markets Transparency
and Accountability Act of 2009, as reported by the House
Committee on Agriculture on October 21, 1998. Both House bills
contain provisions that are similar to title VII of the Senate
bill.
On November 13, 2009, CBO transmitted an estimate for H.R.
3818, the Private Fund Investment Advisers Registration Act of
2009, as ordered reported by the House Committee on Financial
Services on October 27, 2009. H.R. 3818 contains provisions
that are similar to title IV of the Senate bill.
On December 3, 2009, CBO transmitted an estimate for H.R.
3126, the Consumer Financial Protection Agency Act of 2009, as
ordered reported by the House Committee on Financial Services
on October 22, 2009. H.R. 3126 contains provisions that are
similar to title X of the Senate bill.
On December 3, 2009, CBO transmitted an estimate for H.R.
3890, the Accountability and Transparency in Rating Agencies
Act, as ordered reported by the House Committee on Financial
Services on October 22, 2009. H.R. 3890 contains provisions
that are similar to subtitle C of title IX of the Senate bill.
On March 11, 2010, CBO transmitted an estimate for H.R.
2609, the Federal Insurance Act of 2009, as ordered reported by
the House Committee on Financial Services on December 2, 2009.
H.R. 2609 is nearly identical to subtitle A of title V of the
Senate bill.
Estimate prepared by: Federal Costs: Kathleen Gramp, Susan
Willie, Matthew Pickford, Daniel Hoople, and Wendy Kiska;
Federal Revenues: Barbara Edwards; Impact on State, Local, and
Tribal Governments: Elizabeth Cove Delisle; Impact on the
Private Sector: Paige Piper/Bach, Brian Prest, and Sam Wice.
Estimate approved by: Theresa Gullo, Deputy Assistant
Director for Budget Analysis.
IX. REGULATORY IMPACT STATEMENT
In accordance with paragraph 11(b), rule XXVI, of the
Standing Rules of the Senate, the Committee makes the following
statement concerning the regulatory impact of the bill.
NUMBER OF PERSONS COVERED
The reported bill would promote the financial stability of
the United States through multiple measures designed to work
together to improve accountability, resiliency, and
transparency in the financial system by: establishing an early
warning system to detect and address emerging threats to
financial stability and the economy, enhancing consumer and
investor protections, strengthening the supervision of large
complex financial companies and providing a mechanism to
liquidate such companies should they fail without any losses to
the taxpayer, and regulating the massive over-the-counter
derivatives market.
Among those who would benefit from the provisions in the
reported bill include the participants in the U.S. financial
system, such as consumers of financial products who would be
empowered to make more informed choices through better
disclosures, and investors in the capital markets who would be
better protected through greater transparency and improved
corporate governance. Taxpayers would be protected as well, by
ending the possibility that individual companies could be
bailed out as they were in 2008 during the financial crisis
when regulators did not have the ability to liquidate large,
interconnected financial companies in an orderly way. A large,
complex financial company that fails will either go through
bankruptcy, or in the rare, exceptional case where the
bankruptcy of such financial company would threaten financial
stability, the company will be liquidated in an orderly fashion
by the FDIC with funding from the financial services industry,
not from the taxpayers.
Under the reported bill, those who provide financial
services would benefit as well since the bill seeks to ensure
that financial companies operate in a safer, sounder manner
through tougher oversight and accountability without
jeopardizing the financial system through risky, irresponsible
practices. Companies such as AIG, Lehman Brothers, and Bear
Stearns would likely not have collapsed and put the entire
financial system in jeopardy had they been under appropriately
stringent supervision that limited the dangerous financial
activities in which they engaged.
Regulated financial companies will continue to be
regulated, with the larger, more complex and interconnected
financial companies facing increasingly stringent supervision.
(Smaller banks, on the other hand, should not be subject to
additional regulation.) While the overall thrust of the
reported bill is to close gaps in regulations and provide
robust supervision to rein in abusive practices by the weakly
regulated or unregulated financial companies that led to the
financial crisis, some financial companies may see their
regulations rationalized and streamlined through the
consolidation of holding company and prudential supervision
that aims to reduce unnecessary duplication. Certain financial
companies that previously have not been subject to robust
regulation (or any regulation in some cases), including some
Wall Street firms and those financial companies operating
within the unregulated ``shadow'' banking system, will be
subject to supervision for the first time or become subject to
tougher oversight so that their risky activities do not trigger
another financial crisis.
ECONOMIC IMPACT
By promoting financial stability through a broad range of
improvements, it is anticipated that the reported bill would
have a positive economic impact overall by building a solid
foundation upon which the financial system and the economy of
the United States could continue to grow in a sustainable
fashion, with reduced likelihood of, and mitigated impact from,
any potential financial crises.
The costs of the last financial crisis to American workers,
homeowners, and economy have been enormous: 8 million jobs were
lost, more than 7 million homes entered foreclosure, and $13
trillion in American household wealth vanished. The reported
bill seeks to improve the financial architecture of the U.S. to
minimize or eliminate the likelihood of the recurrence of a
financial crisis of such proportions. While no legislation
could eliminate altogether economic cycles and periods of
financial instability, the strengthened infrastructure for the
financial system contemplated by the reported bill is intended
to make the system more resilient and resistant to the adverse
effects of financial instability.
A number of provisions in the reported bill would impact
the U.S. economy positively. For instance, the comprehensive
regulation and rules for how the OTC derivatives market
operates would protect taxpayers and inject greater
transparency into U.S. markets, attracting foreign investment
and increasing U.S. competitiveness. Increasing the use of
central clearinghouses and exchanges as well as setting
appropriate margining, capital, and reporting requirements will
provide safeguards for American taxpayers and the financial
system as a whole. The overall result would be reduced costs
and risks to taxpayers, end users, and the financial system as
a whole.
The provision to prohibit banks and bank holding companies
from proprietary trading and sponsoring and investing in hedge
funds and private equity funds also would serve to protect
taxpayers and reduce risks in the financial system. When losses
from high-risk activities are significant, they can threaten
the safety and soundness of individual banks and contribute to
overall financial instability. Moreover, when the losses accrue
to insured depositories or their holding companies, they can
cause taxpayer losses. In addition, when banks engage in these
activities for their own accounts, there is an increased
likelihood that they will find that their interests conflict
with those of their customers. This prohibition therefore will
reduce potential taxpayer losses at financial companies
protected by the federal safety net, and reduce threats to
financial stability, by lowering the financial companies'
exposure to risk. The provision also would prevent financial
companies protected by the federal safety net, which have a
lower cost of funds, from directing those funds to high-risk
uses.
The creation of the Consumer Financial Protection Bureau
(CFPB) would provide a level playing field for banks and
nonbank financial companies that sell financial products and
services to consumers, subjecting them to uniform rules and
consistent enforcement for the benefit of consumers. It will do
so without creating an undue burden on banks and credit unions.
The CFPB would enable consumers to get clear and effective
disclosures in plain English and in a timely fashion so that
they can shop for the best consumer financial products and
services. The CFPB would stop regulatory arbitrage--it will
write rules and enforce those rules consistently, without
regard to whether a mortgage, a credit card, an auto loan, or
any other consumer financial product or service is made by a
bank, a credit union, a mortgage broker, an auto dealer, or any
other nonbank financial company, so that a consumer can shop
and compare products based on quality, price, and convenience
without having to worry about getting trapped by fine print
into an abusive deal. The CFPB would have been able to head off
the subprime mortgage crisis that directly led to the financial
crisis, because the CFPB would have been able to see and take
action against the proliferation of poorly underwritten
mortgages with abusive terms. The CFPB therefore serves to
provide another safeguard for the U.S. economy, taxpayers, and
consumers.
Several provisions in the bill work together to strengthen
the supervisory infrastructure of the U.S. financial system,
reduce the likelihood that an individual financial company
would become systemically dangerous, and protect taxpayers from
losses if a financial company fails. The Financial Stability
Oversight Council and the Office of Financial Research would
monitor the financial system for emerging risks. The Federal
Reserve would provide supervision to unregulated financial
companies that the Council determines could threaten financial
stability, and impose heightened prudential standards--``speed
bumps''--such as capital, liquidity, and leverage requirements.
If a financial company fails but its bankruptcy would threaten
the financial system, instead of bailing out such company with
taxpayer dollars, the FDIC would be able to step in and
liquidate the company with funds from the largest, riskiest
financial companies and then recover any losses from a broader
set of large, risky financial companies, if there are any
losses after selling off the assets of the failed company in an
orderly fashion to avoid a ``fire sale.'' Taxpayers thus would
not be at risk from the failure of a financial company, and no
financial company would be too big to fail.
PRIVACY
The reported bill is not expected to have an adverse impact
on the personal privacy of individuals.
PAPERWORK
The reported bill seeks to minimize any increase in
paperwork requirements. A number of provisions require
regulators, before they can require reports or obtain
information from financial companies, to first consult with and
obtain such reports or information from other regulators or
other sources to avoid unnecessary duplication and
administrative burden.
X. CHANGES IN EXISTING LAW (CORDON RULE)
On March 22, 2010 the Committee unanimously approved a
motion by Senator Dodd to waive the Cordon rule. Thus, in the
opinion of the Committee, it is necessary to dispense with the
requirement of section 12 of rule XXVI of the Standing Rules of
the Senate in order to expedite the business of the Senate.
XI. MINORITY VIEWS
----------
MINORITY VIEWS OF SENATOR SHELBY, SENATOR BENNETT, SENATOR BUNNING, AND
SENATOR VITTER
April 30, 2010
Background
Chairman Christopher J. Dodd submitted the ``Restoring
Financial Stability Act of 2010'' (the ``bill'' or the
``reported bill'') to the Senate Committee on Banking, Housing
and Urban Affairs (``Committee'') on March 15, 2010. Although
this bill has been improved since a discussion draft was first
introduced in November of 2009, we cannot support it in its
current form. On March 22, the bill was voted out of Committee
without the support of any Republican members. The Committee
did not hold a legislative hearing on the bill. A review of the
hearing list set forth in the majority report reveals that the
Committee did not hold substantive hearings on most of the
provisions in this bill. Although the Committee prepared this
legislation to address the causes of the financial crisis of
2008, the Committee has not conducted a single investigation
into any aspect of the crisis. Furthermore, although the
Committee authorized the creation of the Financial Crisis
Inquiry Commission (S. 386) to study the causes of the crisis,
the Commission will not report back to Congress with its
findings and recommendations until later this year. None of the
Commission's work informed the Committee's consideration of the
reported bill. As a process matter, we believe that the
Committee has yet to conduct the factual inquiries and develop
the legislative record for a bill of this importance. We also
note that the reported version of the bill differed in several
substantive instances from the bill that the Committee
approved. The discussion below is based on the bill that was
actually approved by the Committee.
We offer these dissenting views on the reported bill
because of our strong belief that the bill contains serious
flaws and will undermine the long-term health of the U.S.
economy. The reported bill's shortcomings include its:
institutionalization of government bailouts; creation of vast
and unaccountable new bureaucracies with unprecedented power
and scope; faulty financial regulatory structure; imposition of
costly and unnecessary regulation on American businesses;
abrogation of the bankruptcy code in favor of a resolution
process based not on law and precedent, but rather on the whims
of un-elected regulators; authorization of data collection and
monitoring of American consumers that undermines traditional
civil liberties; creation of barriers-to-entry in financial
services that will further concentrate market-share in the
largest financial institutions; over-reliance on the judgment
of regulators; proliferation of costly and needless litigation;
mandating of significant new costs on small businesses;
establishment of new barriers to capital formation by small
businesses; slanting of corporate government rules in favor of
special-interest investors; and failure to address the massive
problems at Fannie Mae and Freddie Mac.
A detailed explanation of the reasons for Republican
opposition to the reported bill is set forth in this document.
Title I: Financial Stability
Title I of the reported bill establishes a council of
federal financial regulators, the Financial Stability Oversight
Council (``FSOC'' or ``Council''), for systemic risk regulation
(Section 111). The overall mission and structure of the FSOC is
sound. The FSOC would formally bring together for the first
time all federal financial regulators to improve financial
regulation, maintain and monitor financial stability, promote
market discipline, and coordinate the response of the federal
government to future financial crises. The FSOC will enable
coordination and communication across the U.S. financial
regulatory system.
The particular authorities granted to the FSOC, however,
are troubling because they entrench ``too big to fail''
financial institutions as a permanent part of the U.S.
financial system, thereby perpetuating the unfair advantages
these large institutions enjoy over their smaller competitors
and increasing the risk of U.S. financial system instability.
The FSOC is empowered to designate bank holding companies with
over $50 billion in consolidated assets for heightened
regulation by the Federal Reserve (``Fed'') (Sections 115 and
165). The FSOC also can designate nonbank financial companies
for regulation by the Fed.
The definition of a ``nonbank financial company'' is broad.
The term includes all companies, other than bank holding
companies, organized in the U.S. or a U.S. state that are
substantially engaged in activities that are financial in
nature. All such companies whose material financial distress in
the judgment of at least two thirds of the FSOC would ``pose a
threat to the financial stability of the United States'' would
be subject to the FSOC designation and Fed regulation (Section
113). The FSOC systemic designation and follow-on Fed
regulation could apply to broker-dealers, hedge funds, pension
funds, insurance companies, and savings and loan holding
companies (Sections 113 and 165).
This special designation for nonbank financial companies
and large bank holding companies will result in these financial
institutions receiving unfair marketplace advantages. Market
participants will interpret this special regulation as an
implicit government guaranty that prevents these firms from
failing. These expectations will be reinforced by the expanded
authorities that the reported bill grants to regulators to
support designated financial institutions, including the
ability, as provided in Titles II and XI, to subsidize
creditors, lend against questionable collateral, and issue debt
guarantees. The implicit stamp of approval that designated
financial institutions will receive from this regulatory
restructure will allow them to obtain a lower cost of funds and
other unfair advantages. These advantages will lead to higher
shareholder profits and lower counterparty risk. Such firms
will grow larger and subsume smaller firms who do not have
these advantages. As these large firms grow, the ability of the
government to resolve them without taxpayer support diminishes.
If a financial institution grows too large and constitutes too
much of some aspect of financial intermediation, the U.S.
economy may not be able to withstand its liquidation. For
example, the Federal government has had difficulty addressing
Fannie Mae and Freddie Mac because they comprised a majority
stake of the U.S. housing finance market. The reported bill may
replicate this phenomenon for the rest of the U.S. financial
marketplace.
In addition, the reported bill establishes a $50 billion
fund intended to be used in the resolution of a select group of
large financial institutions. The select group that contributes
to the fund will be perceived by markets as having special
protection and will receive unfair funding advantages. Indeed,
Treasury Secretary Timothy Geithner warned that `` . . .
standing fund would create expectations that the government
would step in to protect shareholders and creditors from
losses. In essence, a standing fund would be viewed as a form
of insurance for those stakeholders.''\259\
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\259\Press Release, United States Department of the Treasury,
October 29, 2009.
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Title I of the reported bill also establishes the Office of
Financial Research (``OFR'') (Section 151). The office is
fundamentally flawed, as it poses a grave danger to the civil
liberties of the American people. It has an independent and
unaccountable head with the authority to collect any and all
information from any and all financial companies (Section 153).
The office even has subpoena power (Section 153). No branch of
government has oversight of this office (Section 152). Given
the private and personal nature of information being collected
and monitored by this office, judicial oversight should be
mandated.
Advocates for the Office of Financial Research claim $500
million will be used to purchase servers adequate to store and
analyze data on all financial transactions in the United
States. An additional $500 million will be required to staff
and operate the office. The unrealistic expectation is that
this office will identify future asset bubbles and work with
financial regulators to mitigate them before the pre-identified
risks manifest as financial instability events. But that is not
the entirety of the mission.
The advocates of the office openly claim that the office
will result in cost savings for Wall Street financial
institutions. The claim is that standardizing data reporting
will dramatically reduce back office costs (costs associated
with verifying details of trades with counter parties) and
costs associated with maintaining reference databases (legal
entity and financial instrument databases). The reported bill
requires the office to share data with Wall Street financial
institutions. Morgan Stanley estimates that implementation of a
program like the OFR will result in a 20% to 30% savings in its
operational costs.\260\
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\260\``FAQs: Role of the NIF, Value and Cost.'' Committee to
Establish the National Institute of Finance. 10 Mar. 2010. .
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Title II: Orderly Liquidation Authority
Title II of the reported bill would institutionalize
bailouts by granting the Executive Branch and federal
regulatory agencies permanent authority to rescue firms and
their creditors and shareholders. Rather than curtailing the
ability of the federal government to bail out companies, this
legislation would set the stage for repeated and potentially
larger government bailouts in the future. The limited tools
that regulators used during the recent crisis, often at the
very edge of, if not beyond, their statutory authorities, would
be augmented with new and broader authorities that explicitly
empower regulators to bail out firms and their creditors and
shareholders.\261\
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\261\Despite clear legislative language to the contrary, the FDIC
has interpreted the systemic risk exception under the Federal Deposit
Insurance Act (12 U.S.C. 1823(c)(4)(G)) as authorizing the FDIC to
provide broad financial assistance to financial institutions, including
billions of dollars in debt guarantees. Similarly, although Section
13(3) of the Federal Reserve Act prohibits the Board of Governors from
making equity investments in partnerships and corporations, the Board
of Governors has interpreted its lending authority as authorizing it to
lend to special purpose vehicles that invest in assets of failed firms,
even though such lending has the economic characteristics of equity.
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The centerpiece of these new bailout authorities is the
reported bill's new resolution authority. It would authorize
the Secretary of the Treasury to place any financial company
into an administrative resolution process with the Federal
Deposit Insurance Corporation (``FDIC'') serving as the
receiver (Section 203). As the receiver, the FDIC, with the
consent of the Secretary of the Treasury, is explicitly
authorized to pay creditors and shareholders of the company
more than they would be entitled to receive in bankruptcy
(Section 210(d)(4)). Paying creditors and shareholders more
than they are entitled to is the very definition of a bailout.
The reported bill states that the FDIC should conduct
resolutions with ``a strong presumption'' that creditors and
shareholders bear losses (Section 204). It does not mandate
that they take all of the losses.
The reported bill claims that it is ``protecting taxpayers
from bailouts,'' but it notably does not claim to end bailouts.
Instead, it grants the FDIC the authority to impose assessments
on financial companies to pay for bailouts of creditors and
shareholders. Thus, the reported bill provides a permanent
source of funding for bailouts while claiming that it protects
taxpayers. According to the Congressional Budget Office
(``CBO''), however, the assessments would be tax
deductible.\262\ As a result, taxpayers are directly on the
hook to cover the costs of a resolution. To the extent the
assessments actually are paid by financial companies, the
American public still picks up the tab. First, CBO has
indicated that the assessments will result in reduced
compensation for employees at assessed companies.\263\ Second,
the assessments will be passed down (like all business taxes)
to the consumers in the form of higher prices. It does not
matter whether the funds to pay creditors and shareholders
additional amounts come directly from taxpayers in the form of
taxes or indirectly from the public in the form of assessments
on financial companies. The end result is the same: the
American people will pay for the losses of the investors of
large financial institutions.
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\262\Congressional Budget Office, Cost Estimate: S. 3217 Restoring
American Financial Stability Act of 2010, April 21, 2010.
\263\Id.
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By establishing a mechanism to bail out creditors and
shareholders, the reported bill will worsen the too big to fail
problem that plagues our financial markets. If creditors and
shareholders know that the FDIC will bail them out using this
resolution authority, they will impose far less market
discipline on these firms (such as imposing conditions on the
firm before they invest, removing management, or selling their
interests in the firm). After all, if the government will be
there to ensure that creditors and shareholders do not take
losses if the company fails, any funds that investors spend to
monitor their investments would needlessly reduce their
ultimate profits. And, because investors will abstain from
disciplining these too big to fail firms, the firms will
attract ever larger amounts of capital, allowing them to grow
bigger and giving them a competitive advantage over their
smaller competitors who investors believe are not too big to
fail. Moreover, investors will have incentives to take greater
risks, as they will reap all of the gains while losses will be
transferred to other firms by the resolution authority. In
total, this is the same recipe that produced the colossal
failures of Fannie Mae and Freddie Mac, necessitating a
government rescue that has cost taxpayers more than $127
billion to date.\264\ Accordingly, far from ending bailouts,
the reported bill's resolution authority actually will make our
financial system less safe, more susceptible to crises, and
more dependent on bailouts.
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\264\Federal National Mortgage Association. (2009) 12/31/2009 SEC
Form 10-K Annual Report. (``When Treasury provides the additional funds
that have been requested, we will have received an aggregate of $75.2
billion from Treasury. The aggregate liquidation preference on the
senior preferred stock will be $76.2 billion, which will require an
annualized dividend of approximately $7.6 billion.'') Federal Home Loan
Mortgage Corp. (2010). 2/24/2010 SEC Form 10-Q Quarterly Report. (``To
date, we have received an aggregate of $50.7 billion in funding under
the Purchase Agreement.'')
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The reported bill's resolution authority also suffers from
numerous technical problems. The bill does not provide any
mechanism for ensuring that the resolution authority is not
used to bail out creditors and shareholders of non-financial
firms. Presently, the reported bill would allow a non-financial
firm to be resolved under its resolution authority if (1) it is
a subsidiary of a financial company, or (2) the Secretary of
the Treasury determines that the company was ``primarily''
engaged in activities that are financial in nature. The
Secretary's determination on whether a company is ``primarily''
engaged in financial activities is not reviewable, leaving the
door open for misuse of the resolution authority. No evidence
has been presented to the Committee that supports the use of
the resolution authority to resolve non-financial companies.
Further, the reported bill does not provide any check on
the FDIC as receiver for a covered financial company. There are
no provisions that would permit the removal of the FDIC as
receiver if the FDIC performs poorly in executing its duties
under this title.
In addition, the reported bill does not guard against the
use of the resolution authority to bail out politically
influential creditors and shareholders. The FDIC, with the
consent of the Treasury Secretary, can treat similarly situated
creditors and shareholders differently, including paying some
creditors and shareholders 100 percent (or more) of their
claims while paying others only the amount they would have
received in bankruptcy. This would allow the FDIC and the
Treasury Secretary to bail out politically favored creditors
and shareholders such as foreign governments or politically
influential investors.
Finally, the reported bill contains no provisions to ensure
that the directors, senior executives, and regulators of any
financial company placed into resolution are held accountable.
For example, there are no provisions that address the priority
of the claims of directors and senior executives. In addition,
the bill lacks any provisions requiring an evaluation of the
performance of the primary regulators of a covered financial
company to hold the regulatory staff accountable for any
failings in their supervision of a covered financial company.
Title III: Transfer of Powers to the Comptroller of the Currency, the
Corporation, and the Board of Governors
Title III of the reported bill creates a cumbersome
financial regulatory structure that reinforces expectations
that large financial institutions are too big to fail and that
contains significant gaps in regulatory oversight. By stripping
the Fed of all banking regulatory authority except for bank
holding companies with assets of more than $50 billion, the
reported bill signals to market participants that large
financial institutions have a special regulator, the Fed, which
will not allow any of those institutions to fail. These
expectations are reinforced by the fact that the Fed has the
authority, and has demonstrated recently the willingness, to
provide funding through the discount window and Section 13(3)
of the Federal Reserve Act to prevent its regulated entities
from failing.
The reported bill also contains a significant regulatory
gap because it does not automatically apply heightened
regulatory standards to large savings and loan holding
companies in Section 165 as it does for large bank holding
companies. The majority claims heightened regulatory standards
are needed for our largest financial institutions. Yet their
reported bill exempts savings and loan holding companies from
Section 165. In fact, it is possible to read Section 165 as a
prohibition on applying heightened standards developed for
large bank holding companies to savings and loan holding
companies. This is of particular concern given the fact that
several savings and loans holding companies are among the
largest financial institutions in the country and contributed
to financial instability, including American International
Group (``AIG'') and G.E. Capital. For these and all other
savings and loan holding companies, the majority relies on the
wisdom and judgment of future regulators to determine through a
Financial Stability Oversight Council vote whether to apply
heightened regulatory standards. A superior approach would be
to apply heightened regulatory standards to all holding
companies with an insured depository institution. In addition,
the construct in the reported bill is unworkable for savings
and loan holding companies that also undertake significant
commercial activities. The Fed is not an appropriate regulator
for commercial activities. The reported bill fails to clarify
or address the regulation of savings and loan holding
companies.
Title IV: Regulation of Advisers to Hedge Funds and Others
Title IV of the reported bill has identified hedge funds as
potential systemic risks. To address these risks, the bill
imposes a requirement that hedge fund advisers with more than
$100 million under management register with the Securities and
Exchange Commission (``SEC'' or ``Commission''). Hedge funds
have not been identified as a cause of the financial crisis and
investors in failed funds were not bailed out.
Regulators should have better information about hedge
funds, but hedge fund advisor registration is not the
appropriate approach, and the SEC is not the proper regulator
to carry out systemic risk oversight. The SEC's
responsibilities are protecting investors, facilitating capital
formation, and maintaining fair, orderly, and efficient
markets. The SEC is not a systemic risk regulator, and when it
tried to be with the Consolidated Supervised Entity program, it
failed.\265\
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\265\Of the firms regulated by the SEC under its Consolidated
Supervised Entities (``CSE'') program, one collapsed and its creditors
were bailed out by the Fed (Bear Stearns), one failed and was sold in
bankruptcy (Lehman Brothers), one was rescued in a merger (Merrill
Lynch), and two converted to bank holding companies to obtain a rescue
from the Fed's discount window (Goldman Sachs and Morgan Stanley). The
CSE program never was authorized by Congress. It was created by the SEC
in 2005 to provide consolidated regulation to those select firms to
allow them to avoid consolidated supervision under European Union
regulation. The record of the SEC's CSEs programs must certainly stand
as among the greatest regulatory failures in financial history,
especially if one considers that the financial crisis started in
September 2007 with the failure of two investment funds sponsored by
Bear Stearns. Its record should serve as a reminder of the systemic
problems and financial crises that flawed regulatory structures and
agencies can produce. While well conceived regulation can enhance
markets, poorly conceived regulation, especially when the regulation
involves a captured regulator, can have devastating effects on the
overall economy, financial stability, and the financial well-being of
millions of Americans.
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It is likely that investors will treat SEC registration as
an SEC seal of approval. Fraudulent hedge fund advisors likely
will use registration as a marketing tool.\266\ Investor
protection is an important job for the SEC, but its resources
are not endless, and the SEC notoriously is unable to inspect
its current stable of advisors on a regular basis.\267\ Hedge
funds are open only to wealthy investors on the theory that
those investors can hire people to advise them about
investments and that, ultimately, they can afford to lose
money. Investors who do not meet the wealth threshold or who
choose to invest in more closely regulated vehicles can invest
in public investment companies. Limited SEC resources should
not be diverted from regulated public investment companies,
such as mutual funds, in order to monitor hedge fund advisors,
as the reported bill proposes to do. If the SEC is spending its
resources in this manner, it will not be long before investors
that do not meet the accredited investor threshold start
demanding to be allowed to invest in hedge funds. It will be
hard to counter the argument that they should have access to
investments on which the SEC is spending its investigative
resources.
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\266\Bernard Madoff used the fact that the SEC had inspected his
firm as a way to reassure skeptical investors. See SEC Office of
Investigations, Investigation of Failure of the SEC to Uncover Bernard
Madoff's Ponzi Scheme--Public Version, Aug. 31, 2009, at 427 (available
at:
http://www.sec.gov/news/studies/2009/oig-509.pdf) (``In addition,
private entities who conducted due diligence stated that Madoff
represented to them that the SEC had examined his operations when they
raised issues with him about his strategy and returns.'').
\267\See, e.g., Testimony by Mary Schapiro, Chairman of the
Securities and Exchange Commission, before the Subcommittee on
Financial Services and General Government of the House Committee on
Appropriations (Mar. 17, 2010) (available at: http://www.sec.gov/news/
testimony/2010/ts031710mls.htm) (``It is important to note, however,
that even with an increase in the number of exams these additional
resources will enable us to conduct, we anticipate examining only nine
percent of SEC registered investment advisers and 17 percent of
investment company complexes in FY2011.'').
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The reported bill also exempts venture capital and private
equity advisors, but delegates to the SEC the difficult task of
defining what those terms mean. The SEC, as part of its failed
attempt several years ago to require hedge fund advisors to
register, distinguished hedge funds from other types of funds
by looking to the length of the investor lock-up period. In
order to avoid registration, some hedge funds simply extended
their lock-up periods beyond the two year cut-off. Investors'
ability to exit a fund with which they were dissatisfied was
thus curtailed. The reported bill may perpetuate this problem.
The reported bill is not the right way to achieve the
objective of giving the appropriate regulator the information
necessary to assess the potential systemic risks posed by large
hedge funds, and it threatens to divert the SEC from its core
mission.
Title V: Insurance
Title V would establish an Office of National Insurance
(``ONI''). This office would remedy the lack of insurance
expertise in the Executive Branch revealed during the insurance
crises triggered by the September 11, 2001 terrorist attacks
and by the failure of AIG in 2008. As was revealed during the
Committee's March 5, 2009 hearing on the Fed's rescue of AIG,
the problems at AIG were not limited to the company's
derivatives operations in its Financial Products division. As
discussed further in Title VI, there were also serious problems
with several of AIG's insurance companies due to the collapse
of their massive securities lending operation. In light of the
serious ramifications that the failure of an insurance company
can have on our financial system, as demonstrated by the
collapse of AIG, we believe that among the issues that the
reported bill presently mandates the director of ONI to study,
there should be a study of the adequacy of state guaranty funds
to handle the failure of large, interconnected, and
international insurance companies.
Title VI: Improvements to Regulation of Bank and Savings Association
Holding Companies and Depository Institutions
Title VI of the reported bill contains improvements to the
regulation of bank and savings and loan holding companies and
depository institutions. What notably is lacking in Title VI is
any provision to enhance regulatory oversight of large
insurance companies. During the financial crisis, several
prominent insurance companies received a Federal bailout
through the TARP program. In addition, the collapse of AIG
revealed serious shortcomings in the regulation of large,
interconnected, and international insurance companies. The
failure of AIG was due, in large part, to the massive
securities lending operation that several state-regulated AIG
insurance companies ran collectively. Documents submitted at
the Committee's sole hearing on AIG indicated that several of
these insurance companies would have been insolvent had not the
Fed re-capitalized them as part of its bailout. The record
revealed that the problems at AIG were well-known by its
regulators at the Office of Thrift Supervision and by state
insurance commissioners, but they failed to take sufficient
action to prevent the collapse of the company.\268\ In
addition, it has recently been revealed that Treasury Secretary
Geithner was informed personally by AIG of the company's
problems weeks before AIG received a bailout from the Fed.\269\
The Secretary also failed to take preventive action. While
insurance regulation is a complex matter and our state system
largely has functioned well for nearly two hundred years, the
size and international reach of many insurance companies has
raised legitimate questions, including whether reforms are
needed to reflect changes in the marketplace. The failure of
the reported bill to include provisions to ensure the proper
oversight of large, interconnected, and international insurance
companies like AIG is a glaring omission.
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\268\Senate Committee on Banking, Housing, and Urban Affairs,
``American International Group: Examining what went wrong, government
intervention, and implications for future regulation,'' March 5, 2009.
\269\Sorkin, Andrew Ross, ``Too Big To Fail'' p. 207, 235, (Viking
2010).
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It is also worth noting that the reported bill remains
silent with respect to the implementation of prompt corrective
action during the economic downturn. Enacted as part of the
Federal Deposit Insurance Corporation Improvement Act of 1991,
prompt corrective action was designed to protect the Deposit
Insurance Fund by requiring regulators to resolve failing banks
before they incur substantial losses. An examination of the
material loss reviews for the FDIC's resolution of banks over
the past 3 years reveals that the resolution of banks regularly
results in losses of 20 to 30 percent of assets.\270\ Under
prompt corrective action, regulators are required to close any
bank whose capital falls below 2 percent of tangible net
equity. The Committee has yet to hold a single hearing on the
effectiveness of regulators in implementing prompt corrective
action despite the substantial risks to the taxpayers involved.
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\270\Under Section 38(k) of the Federal Deposit Insurance Act, the
inspector general for the appropriate Federal banking agency must make
a written report reviewing the agencies supervision and implementation
of prompt corrective action whenever the Deposit Insurance Fund incurs
a material loss with respect to an insured depository institution. The
term ``material loss'' is defined as a loss that exceeds the greater of
$25 million or 2 percent of an institution's total assets at the time
the FDIC was appointed receiver.
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The Committee also has failed to develop a record to
demonstrate a link between proprietary trading and financial
instability during the housing and credit market crisis. Yet,
the reported bill contains a broad prohibition on proprietary
trading. Insured depository institutions benefit from a
government provided deposit insurance subsidy so robust
activity restrictions, including proprietary trading
limitations, may be warranted. But, the policy rationale for
extending a proprietary trading ban beyond insured depositories
is less compelling as non-insured depository institutions
should not benefit from the government subsidies provided by
the FDIC.
Title VII: Improvements to Regulation of Over-the-Counter Derivatives
Markets
In addressing the regulation of the U.S. over-the-counter
(``OTC'') derivatives market, the reported bill is flawed in
its objectives and the mechanics for achieving those
objectives. Rather than focusing on the key goals of regulatory
access and authority and greater use of central clearing, the
bill attempts to restructure dramatically the OTC derivatives
market. It does so without adequate regard for potentially
severe unintended consequences, which include increasing
systemic risk and outsourcing jobs to markets overseas, harming
the U.S. economy.
The reported bill, despite its purported commitment to
regulatory transparency, does not even reach significant
segments of the OTC derivatives market. For example, a large
percentage of the OTC market consists of foreign exchange
derivatives which are explicitly carved out of the bill.
Similarly, the definition of a ``swap,'' which determines the
bill's coverage, omits a category of swaps that, before now,
has been included in the definition.\271\ Rather than casting a
wide net and then making appropriate exclusions, the bill
leaves significant portions of the OTC swaps market in the
dark.
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\271\Specifically, the Gramm-Leach-Bliley Act treated as a ``swap
agreement'' any agreement, contract, or transaction that ``provides for
the purchase or sale, on a fixed or contingent basis, of any commodity,
currency, instrument, interest, right, service, good, article, or
property of any kind.'' These are not ``swaps'' in the reported bill.
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The bill will have deleterious effects in the derivatives
markets and in the marketplace as a whole. The highly
international swaps market, which already is well established
in Europe and Asia, may simply move offshore and beyond U.S.
regulators' reach to a jurisdiction with a more rational
regulatory regime.\272\ Corporations that currently use
derivatives to manage their risk and may not be able to access
foreign markets may choose simply not to manage their risk at
all. Unhedged corporate risks will result in higher prices and
greater price volatility for consumers, and less innovation and
capital investment. Companies that cannot withstand a large
unhedged risk may fail, resulting in large job losses.
Alternatively, corporations may continue to use derivatives
subject to the bill's strict requirements for collateral.
Setting aside collateral in the required amounts will cause
companies, already having a difficult time raising capital, to
forgo other valuable uses of their capital. The effect on the
real economy and the job market would be substantial. One
estimate suggests that mandatory clearing and margining would
force companies to set aside $900 billion in capital that would
otherwise be used to build factories, hire workers, and fund
research and development.\273\
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\272\Less-established overseas markets, such as Malaysia, have also
expressed interest in attracting OTC derivatives trades. See, e.g.,
Financial Times, ``Malaysia bourse plans derivatives boost'' (April 27,
2010) (available at: http://www.ft.com/cms/s/0/5fdb7ab8-5222-11df-8b09-
00144feab49a.html).
\273\See, e.g., Keybridge Research, An Analysis of the Business
Roundtable's Survey on Over-the-Counter Derivatives (Apr. 14, 2010)
(available at: http://www.businessroundtable.org/sites/default/files/
BRT%20OTC%20Derivatives%20Survey%20284%2014%2010%29.pdf) (finding that
``a 3% margin requirement on OTC derivatives could be expected to
reduce capital spending by $5 to $6 billion per year, leading to a loss
of 100,000 to 120,000 jobs, including both direct and indirect
effects''); Letter from the Natural Gas Supply Association and the
National Corn Growers Association to Senate Majority Leader Reid,
Senator Lincoln, and Senator Chambliss (April 15, 2010) (available at:
http://www.ngsa.org/newsletter/pdfs/2010%20Press%20Releases/16-
Corn%20Growers%20Join%20Drumbeat%20Against%20Mandatory%20Clearing.pdf).
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The reported bill, by imposing bank-style capital
requirements that are as strict or stricter for non-bank
entities, likely will drive some of these entities out of the
market and concentrate the market further among the dealers who
already have established a powerful foothold in the market.
Capital requirements are not necessary for non-banks that do
not have access to federal deposit insurance or another form of
federally subsidized insurance in the event of default.
The reported bill is rooted in a presumption that central
clearing is always risk-reducing. While central clearing can
reduce risk and should be encouraged, its abilities to do so
should not be overstated. First, some clearinghouses may be
stronger than others. A clearinghouse that is poorly run and
poorly regulated may not be a strong counterparty. Second, even
a well-regulated clearinghouse is not a riskless
counterparty.\274\ Third, there is no basis for the bill's
categorical claim that there is ``a greater risk to the swap
dealer or major swap participant and to the financial system
arising from the use of swaps that are not centrally cleared''
that warrants ``substantially higher capital requirements'' for
swaps that are not centrally cleared. Fourth, specialized
dealers in bilateral markets can monitor and manage the risks
of complex, illiquid derivatives contracts and complex, opaque
counterparties more effectively than all-purpose clearinghouses
that are designed to clear standardized liquid contracts among
clearing members.
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\274\For example, last year, the Federal Reserve Board of Governors
assigned a 20 percent risk weighting to ICE Trust, which is the same
risk weighting that the individual members of the clearinghouse
typically get. See letter from the Federal Reserve Board of Governors
to Cleary, Gottlieb, Steen and Hamilton LLP (June 5, 2009) (available
at: http://www.federalreserve.gov/boarddocs/legalint/
BHC_ChangeInControl/2009/20090605.pdf) (``Exposures to ICE Trust in the
form of Margin and [Guaranty Fund] Contributions are not materially
riskier than exposures to the participants themselves, and the
exposures to ICE Trust, therefore, need not be subject to higher risk
weights.'').
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Moreover, most participants in the OTC market, such as
hedge funds and commercial end users, do not clear directly
through a clearinghouse. As a result, even when they clear a
derivative, they do not directly face the clearinghouse.
Instead, they clear through a firm that is a member of the
clearinghouse. Such indirect access to clearinghouses exposes a
market participant to credit risk associated with that clearing
member and its other customers. In the event of the failure of
the clearing member or one of its customers, other customer
assets may be at risk. Certain protections can be put in place
to minimize the likelihood of loss for non-defaulting
customers, but some level of risk remains. As the CME Group
notes, ``While the policies applicable to the segregation of
customer monies for products traded in regulated markets are
specifically designed to protect customers from the
consequences of a clearing member's failure, they do not always
provide complete protection should the default be caused by
another customer at the firm.''\275\
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\275\CME Group, CME Clearing Financial Safeguards (available at:
http://www.cmegroup.com/clearing/files/financialsafeguards.pdf)
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The reported bill improperly delegates significant policy
decisions to regulators and raises the possibility of arbitrary
implementation. For example, market participants' statuses as
``major swap participants'' would turn on the judgment of
regulators, who would have an incentive to make their
regulatory reach extend as far as possible. Moreover, because a
``major swap participant'' is defined, in part, by whether a
person would cause his or her counterparties ``significant
credit losses,'' a person's status will depend, in part, on how
well its counterparties manage risk. This approach will
undermine, rather than enhance, market discipline.
The bill, in trying to address systemic risk concerns,
gives rise to a new set of concerns. As soon as one
clearinghouse starts clearing a swap, there will be a
presumptive mandate to clear the swap. In other words,
clearinghouses' profit-driven, competitive decisions on when to
start clearing which products would drive the clearing mandate.
Moreover, the bill would require the SEC and the Commodity
Futures Trading Commission (``CFTC'') to identify swaps that
clearinghouses had not asked for permission to clear that, in
the judgment of the SEC and CFTC, should be accepted for
clearing. By allowing the regulators to force clearinghouses to
accept swaps for clearing, the bill could force clearinghouses
to accept for clearing swaps the risks of which they do not
understand. Pressuring clearinghouses into clearing in this
manner could sow the seeds for a clearinghouse failure sometime
in the future.
The reported bill makes it very difficult for anyone to get
an exemption from clearing and exchange trading requirements.
It allows the SEC and CFTC, with prior approval by the FSOC, to
exempt a swap if one of the parties is not a swap dealer or
major swap participant and does not meet the eligibility
requirements of a clearing organization. Faced with the
prospect of a long, burdensome exemptive process, the bill will
dissuade corporations from using swaps to offset their risks.
Even if a corporation succeeds in getting an exemption from the
clearing requirement, it will be subject to margin requirements
unless it can obtain an exemption. Exemptions only will be
available for swaps that fit within the narrow and technically
complex Generally Accepted Accounting Principles hedging
category.
The reported bill requires that cleared swaps also be
traded on an exchange or exchange-like facility. This
requirement will effect a significant change in market
structure. End users will face higher, not lower, costs as
their dealers will find it more difficult to lay off the risk
that they take on. Indeed, the exchange trading requirement may
cause dealers to retain more risk on their books. Other markets
have been allowed to develop in a manner that serves the
interests of investors. Proponents of an exchange trading
requirement cite improved price transparency. Exchange trading
is not necessary for transparency, however. Through a system
like the TRACE system employed in the corporate bond market,
valuable post-trade transparency can be communicated to
investors for use in assessing execution quality, marking their
books, and assessing pricing in future transactions. SEC
Chairman Mary Schapiro and independent academics have embraced
a TRACE-like solution for the OTC derivatives market.\276\
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\276\See ``Stronger regulation would help bring financial swaps out
of the shadows,'' Washington Post OpEd by Mary Schapiro (April 2, 2010)
(available at: http://www.washingtonpost.com/wp-dyn/content/article/
2010/04/01/AR2010040102801.html), and the statement of the Shadow
Financial Regulatory Committee on Derivatives, Clearing and Exchange-
Trading (April 26, 2010) (available at: http://www.aei.org/docLib/
Statement%20No.%20293-%20Derivatives-
%20Clearing%20and%20Exchange%20Trading.pdf).
---------------------------------------------------------------------------
Title VIII: Payment, Clearing, and Settlement Supervision
Title VIII of the reported bill would give the Council
broad power to identify financial market utilities and payment,
clearing or settlement activities that it deems to be now, or
likely to become, systemically important. Those entities and
activities would then be subject to risk regulation by the
Fed's Board of Governors. This title is another example of the
bill's inclination to leave difficult decisions to regulators.
Forcing regulators to determine when someone or something ought
to be regulated is an inappropriate delegation of Congressional
power. Moreover, a regulator charged with the task of
identifying regulatory targets has every incentive to cast its
net wide to obtain additional jurisdiction and avoid
accusations of regulatory timidity in the event of a future
problem.
The egregiousness of this title's delegation of
Congressional decision-making derives largely from the broad
manner in which key terms are defined. ``Payment, clearing and
settlement activities,'' for example, include any ``activity
carried out by 1 or more financial institutions to facilitate
the completion of financial transactions.'' Such an activity is
``systemically important'' if ``the failure of or disruption to
[that activity] could create, or increase, the risk of
significant liquidity or credit problems spreading among
financial institutions or markets and thereby threaten the
stability of the financial system.'' With definitions like
these guiding the Council, it could decide to assign any aspect
of the financial market to the Fed.
Once an entity or activity is identified, the Fed is given
broad authority to set risk management standards that can
address any areas that the Fed deems necessary to promote risk
management and safety and soundness, reduce systemic risks, and
support the stability of the broader financial system. In other
words, this title gives the Fed unfettered discretion to
regulate entities and activities that the Council determines
``are, or are likely to become, systemically important.''
Private enterprises that are deemed to be of systemic
importance will have to get preapproval from the Fed before
making any material changes in their operations.
Lack of regulatory accountability contributed to the recent
financial crisis. This title exacerbates the problem by
allowing the Council to bring the Fed into significant sectors
of the financial system as a back-up regulator. If a problem
arises, both the Fed and the relevant supervisory agency will
have someone else to blame. A more sensible approach would be
for Congress to identify the existing financial market
utilities and payment, clearing and settlement activities that
merit greater oversight and provide the appropriate regulator
with the appropriate authority. The Council could be given the
authority to identify additional systemically important
utilities and activities and make regulatory recommendations to
Congress.
Title IX: Investor Protections and Improvements to the Regulation of
Securities
Title IX of the reported bill is a ``Christmas tree'' of
amendments to the securities laws, many of which are not
related to the recent crisis and will not help to prevent
another crisis. In addition, many were not the subject of
Committee hearings. Some of these issues are important and
warrant consideration by Congress and the SEC in the future.
Considering them now as part of this bill is a distraction from
the issues that are central to the bill and deserve Congress's
undivided attention. Some of the issues that appear in Title IX
have been on special interest wish lists for many years. The
reported bill offers a convenient vehicle to pass them into law
without the scrutiny they deserve.
Subtitle A establishes a permanent investment advisory
committee at the SEC to advise the Commission on setting and
implementing its regulatory priorities and promoting investor
confidence. The intention may be good, but the statute
implements it in a manner that ensures that special interests
that may not serve investors' interests have a seat at the SEC
rulemaking table. It also establishes an Office of Investor
Advocate to serve the same function as the SEC's existing
Office of Investor Education and Advocacy.
Subtitle B relates to enforcement issues. It includes a
provision to protect and reward SEC whistleblowers. The value
of whistleblowers was illustrated vividly by the role of Harry
Markopolos in identifying the Madoff fraud, even though his
warnings to the SEC went unheeded. Nevertheless, as established
in the bill, the whistleblower provision does not afford the
SEC with appropriate discretion and would force the SEC to
devote considerable resources to defending its decisions with
respect to whistleblower awards. For example, the bill would
require the SEC to pay whistleblowers not less than ten percent
of the monetary sanctions collected and would allow
dissatisfied whistleblowers to appeal to the United States
Court of Appeals.
Subtitle B also rolls back the National Securities Market
Improvement Act by giving state regulators a role in regulating
Regulation D offerings and by instituting a lengthy pre-
approval process for such offerings which are available only to
accredited investors. Legitimate entrepreneurs will be unable
to fund their projects or will be forced to struggle through a
slow and unpredictable bureaucratic process before they can
raise money. At a time when the economy is weak and jobs are
scarce, financial reform legislation should attempt to
encourage capital formation and innovation, not discourage it
by erecting new obstacles for our entrepreneurs.
Subtitle C attempts to address credit rating agencies. The
bill's approach only would aggravate the over-reliance problem,
however, undermining one of the key recommendations of the
Treasury white paper on financial reform.\277\ The bill also
undermines the objectives of the 2006 Credit Rating Agency
Reform Act, which focused on increasing competition, improving
disclosure, and addressing conflicts of interest. The reported
bill cites the systemic importance of, and investor reliance
on, credit ratings as a justification for giving the SEC a new
role, monitoring the accuracy of credit ratings. Excessive
investor reliance on credit ratings was at the root of the
recent crisis. Encouraging greater reliance on credit ratings
by promising that the SEC will identify and punish inaccurate
rating agencies is exactly the opposite of what a financial
reform bill ought to achieve. Reducing investors' perceptions
that the SEC is looking over the shoulders of the credit rating
agencies to ensure that they are doing a good job would help to
encourage investors to do their own due diligence. Some of the
bill's attempts to address conflicts of interest, such as
imposing strict independence requirements for boards of
directors and qualification standards for credit rating
analysts, will discourage competition by setting up barriers to
entry for credit rating agencies considering registering as
nationally recognized statistical rating organizations. The
bill also includes a new liability standard for all credit
rating agencies, which will make credit rating agencies an easy
target for lawsuits. This provision also is likely to harm
competition and the value of credit ratings.
---------------------------------------------------------------------------
\277\See ``Financial Reform: A New Foundation,'' U.S. Department of
Treasury (available at: http://www.financialstability.gov/docs/regs/
FinalReport_web.pdf), page 44, ``We propose several initiatives . . .
reducing the incentives for over-reliance on credit ratings.''
---------------------------------------------------------------------------
The reported bill also threatens a healthy return of the
securitization markets. The centerpiece of Subtitle D is a five
percent risk retention requirement for securitizations. The
requirement is a one-size-fits-all solution in a very diverse
securitization marketplace. In combination with accounting and
bank capital rule changes, a risk retention requirement could
force the entire securitization to be retained on bank balance
sheets for accounting and capital purposes. Securitizations
would then become economically unworkable. The bill would
permit less than five percent risk retention in cases in which
the originator complies with underwriting standards set by the
SEC, along with the bank regulators. A more sensible approach
would direct bank regulators to set underwriting standards that
include a down payment requirement for all residential
mortgages.\278\ The SEC, a disclosure regulator, should focus
its efforts on improving disclosure about the underlying assets
in a securitization pool to enable investors to conduct due
diligence, rather than instilling in investors a sense of
complacency by an arbitrary risk retention requirement.
---------------------------------------------------------------------------
\278\See John C. Dugan, Comptroller of the Currency, Speech before
the American Securitization Forum (Feb. 2, 2010) (available at: http://
www.occ.treas.gov/ftp/release/2010-13a.pdf ) (``But while lax
underwriting is plainly a fundamental problem that needs to be
addressed, mandatory risk retention for securitizers is an imprecise
and indirect way to do that, and is by no means guaranteed to work. How
much retained risk is enough? And what type of retained risk would work
best--first loss, vertical slice, or some other kind of structure?'').
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Subtitle E addresses executive compensation in a number of
unproductive ways. First, it requires public companies to have
annual votes on executive compensation. This one-size-fits-all
solution imposed at the federal level tramples over state
corporate law, forces shareholders to pay for something that
they may not want, and exacerbates short-term thinking. The
subtitle also imposes a requirement on public companies to
disclose the ratio of the median employee compensation to the
chief executive officer's compensation. Although provisions
like this appeal to popular notions that chief executive
officer salaries are too high, they do not provide material
information to investors who are trying to make a reasoned
assessment of how executive compensation levels are set.
Existing SEC disclosures already do this. More generally, the
subtitle's prescriptive approach hinders corporations from
devising policies that work for the unique circumstances of
their corporations.
Subtitle G likewise forces all public corporations to adopt
uniform approaches to corporate governance regardless of
whether those approaches would serve the needs of shareholders
and without regard for the central role of states in
establishing corporate governance standards. Subtitle G imposes
a majority voting requirement for directors of public
corporations, without any evidence that majority voting
benefits shareholders. In fact, AIG, Washington Mutual, Lehman
Brothers, Citigroup, Merrill Lynch, Bank of America, and
Wachovia all required majority voting before the financial
crisis. Special interest groups hope that the majority voting
requirement will work in conjunction with the bill's proxy
access requirement to give them special access to corporate
boardrooms. Proxy access is designed to permit shareholders to
put their nominees for the board on the company ballot at the
company's expense. Mandating proxy access raises investor
protection concerns because all shareholders are forced to fund
campaigns by one shareholder to gain representation on the
board and because directors are supposed to represent the
interests of the shareholders as a whole, not particular
special interests. Despite these concerns, some shareholders
already are able to choose to implement proxy access. Changes
in state law have made it possible for shareholders to tailor
proxy access provisions that work for their particular
corporations. A federal proxy access mandate is not needed and
would deprive shareholders of the very voice it purports to
give them.
Subtitle H of the reported bill deals with municipal
securities, an area that warrants attention. Nevertheless, the
subtitle includes some troubling features. Fines collected for
enforcement violations would be shared between the SEC and the
Municipal Securities Rulemaking Board. Allowing these entities
to profit from their enforcement actions provides them with a
profit motive for bringing cases, which would harm the
credibility of the agency.
Subtitle I of the bill would, among other things, expand
the mission of the Public Company Accounting Oversight Board
(``PCAOB'') to include overseeing auditors of broker-dealers.
Because the PCAOB is still working on fulfilling its initial
mission, a large influx of new registrants will pose additional
resource challenges. To minimize this burden, the legislation
should not extend to auditors of Introducing Brokers, who do
not handle customer funds.
Subtitle J of the bill would remove the SEC from the
appropriations process and permit it to fund itself through the
fees and assessments that it collects. It could set its budget
at any level that it determined proper and exceed that budget
at its discretion. In the event the SEC spends more than its
budget, it is permitted, but not required, to notify Congress
of the amount of additional money and anticipated uses of that
money. In the wake of some of the largest regulatory failures
in the SEC's history and the embarrassing scandal involving
senior SEC officials repeatedly downloading pornography on
government computers during the height of the financial crisis,
it is surprising that Congress would decide to make the SEC
less accountable. Additional resources are warranted for the
SEC's important responsibilities, but they should be
accompanied by a responsibility to account to Congress for how
those resources are spent.
Title X: Bureau of Consumer Financial Protection
Title X creates a massive new entity whose power and
autonomy have no current equivalent anywhere else in the
Federal government. The Bureau of Consumer Financial Protection
(``Bureau'') will have no meaningful coordination with the
safety and soundness regulators to ensure that banks will not
fail or be critically weakened as a result of a consumer rule.
Indeed, the Bureau would have the authority to trump the safety
and soundness regulators, thereby creating instability in our
nation's financial system. The manner in which the legislation
separates safety and soundness and consumer protection
regulation is similar to the regulatory structure of Fannie Mae
and Freddie Mac. In that instance, the Department of Housing
and Urban Development (HUD) set consumer standards while the
Office of Federal Housing Enterprise Oversight regulated for
safety and soundness. Ultimately, the consumer standards set by
HUD undermined the solvency of Fannie and Freddie. Fannie and
Freddie are currently the largest recipients of bailout funds.
Under the reported bill, the Bureau would regulate every
aspect of financial transactions. The Bureau would have
enormous reach into Main Street companies like orthodontists,
home repair and renovation contractors, and anyone else who
extends credit in more than four installments. It would set
lending standards; determine what type of documents lenders
could use; and require banks to make a certain percentage of
their loans to specific, politically favored borrowers (i.e.,
housing authorities or ``green'' businesses). The Bureau could
force all lenders to use the same lending forms and terms and
conditions.
The reported bill provides the Bureau with an enormous
taxpayer-provided funding source without executive or
congressional oversight of its budget. The legislation states
that the budget for the new Bureau shall be 12 percent of the
overall operating budget of the Federal Reserve System for
fiscal year 2009. This would allow the Bureau to command
approximately $650 million of Fed resources. Currently, the
Office of the Comptroller of the Currency (``OCC'') has an
overall operating budget of $750 million, and the OCC handles
both consumer protection supervision and prudential
supervision.
The reported bill also undermines more than a century of
precedent on preemption with respect to national banks.
Presently, state laws that conflict with the National Bank Act
are pre-empted because Congress has long sought to create a
national financial market and ensure the efficient regulation
of national banks. The reported bill, however, effectively
eliminates preemption and allows states to set their own
regulations under certain circumstances. Furthermore, the bill
requires the OCC and the courts to determine on a case-by-case
basis which state laws are pre-empted, which will create
significant legal uncertainty and generate unnecessary
litigation. In addition, the bill would allow State Attorneys
General to bring class action suits against national banks,
usurping the responsibility of federal regulators and creating
even more needless litigation.
Finally, the Bureau poses a threat to Americans' civil
liberties. Under Section 1022, the new Bureau would collect any
information it chooses from businesses and consumers, including
personal characteristics and financial information. Americans
could be required to provide the new consumer agency with
written answers, under oath, to any question posed by the
Bureau regarding their personal financial information. The
Bureau would have the authority to monitor transactions such as
personal deposit account activity, credit card usage, and how
much an individual spends on groceries. This is a massive new
grant of authority for an entity whose budget is derived from
taxpayer funds.
Title XI: Federal Reserve System Provisions
During the recent financial crisis, the FDIC put American
taxpayers at risk by guaranteeing trillions of dollars of
private debt. Title XI of this bill seeks to institutionalize
such guarantees, under the rubric of ``emergency financial
stabilization'' authority, providing permanent authority to put
taxpayer resources at risk to insure private debt whenever the
Fed and FDIC deem it appropriate. No regulator should be
allowed to expose taxpayers to trillions of dollars of risk
without express approval from Congress.
During the crisis, the Fed contributed to creating moral
hazard by vastly expanding use of its discount window to fund a
variety of financial market participants, including some over
which it had no oversight. The Fed also created new lending
facilities to direct liquidity and credit to markets that were
deemed most stressed and systemically important. The Fed
ballooned its balance sheet from a pre-crisis level of around
$800 billion to over $2.2 trillion. Those resources are not
free. Those resources are liabilities of the Fed, created
through the Fed's money creation powers, and are therefore also
liabilities of taxpayers. This bill seeks to institutionalize
Fed support to whichever market segment it and the Treasury
deem to be in need of liquidity. The Fed may make loans and
take collateral that the Fed finds is to its ``satisfaction.''
The Fed does need to perform its lender of last resort
function but should only do so to briefly assist firms who are
solvent and in need of liquidity that cannot readily be
obtained in the open market. The lender of last resort function
of a central bank does not involve long-term loans to insolvent
firms based on questionable collateral. Yet, this bill seeks to
enshrine the Fed's ability to lend to ``any program or facility
with broad-based eligibility,'' taking as collateral whatever
satisfies the Fed. The broad-based and vague language governing
the Fed's emergency lending authorities is an invitation for
future governments to avoid hard decisions and shift them to
the Fed. With trillions of dollars of taxpayer resources likely
to be on the line, the language in the bill governing the Fed's
emergency lending power is far too loose.
Furthermore, the reported bill expands and codifies the
FDIC's broad ability to guarantee the debt of depositories and
of depository holding companies in a loosely defined
``liquidity event.'' The amounts of the guarantees are
unlimited. The President may, or may not, submit a report to
Congress on the FDIC's plan to issue guarantees. Most
troubling, however, is that there is no requirement that a
company that receives guarantees and defaults on its
obligations be taken into an FDIC receivership, bankruptcy, or
resolution. Thus, the FDIC and Treasury could prop up whatever
companies they choose. Moreover, there is ample room to grant
debt guarantees in routine stressful, yet not crisis,
circumstances given the broad definitions.
We believe that the Treasury Secretary and the Fed should
be required to enter into an ``Accord'' to establish clear
rules on the use of 13(3) of the Federal Reserve Act and the
Fed's balance for fiscal purposes.
Title XII: Improving Access to Mainstream Financial Institutions
Title XII was inserted quietly into the Dodd bill at the
last minute as part of the manager's amendment during the
Committee mark-up. It was not considered by the Committee.
Title XII creates a grant program that would give certain
financial institutions, and others, taxpayer dollars to
``recapture a portion or all of a defaulted loan'' (Section
1206). The purpose of the grant program is to encourage certain
financial institutions, and others, to get low- and moderate-
income individuals to establish accounts at their institutions.
We do not support using taxpayer dollars to pay financial
institutions to attract new customers, and then cover the
losses if the new customers default on the loans. This is an
iteration of ``heads Wall Street wins, tails the taxpayer
loses.'' This is replicating on a smaller scale the precise
practices that led to the bailouts of Fannie Mae and Freddie
Mac.
Government sponsored entities
Fannie Mae and Freddie Mac played major roles in the
financial crisis. Combined, these two institutions represent
nearly $5.5 trillion in business, and they have been in
conservatorship since September 6, 2008.\279\ Despite this, the
reported bill does nothing to address the future of the
Government Sponsored Enterprises.
---------------------------------------------------------------------------
\279\Monthly Summary Report, February 2010, Fannie Mae, and Monthly
Volume Report, February 2010, Freddie Mac.
---------------------------------------------------------------------------
In doing so, the reported bill leaves uncertainty in the
secondary mortgage market. As Fannie Mae and Freddie Mac have
such a large influence on the market, private sector investment
will not achieve optimal levels until investors are certain as
to the future of these institutions. By remaining silent on
their futures, the reported bill prevents the private sector
from fully committing to the secondary mortgage market. Without
a properly functioning secondary mortgage market, additional
pressure falls upon the GSEs, the Federal Housing
Administration, the Veterans Administration and Ginnie Mae.
This additional pressure grows these entities, concentrating
risk with the taxpayer rather than in the private sector, and
increases the difficulty of reforming Fannie Mae and Freddie
Mac.
Despite this, the reported bill takes no interim steps to
protect taxpayers. On December 24, 2009, the Treasury
Department and the Federal Housing Finance Administration
(``FHFA'') announced that the Preferred Stock Purchase program
would be amended to ``allow the cap on Treasury's funding
commitment under these agreements to increase as necessary to
accommodate any cumulative reduction in net worth over the next
three years.'' It further allowed Fannie Mae and Freddie Mac
higher portfolio holdings than previously mandated.\280\
---------------------------------------------------------------------------
\280\Press Release: ``Treasury Issues Update on Status of Support
for Housing Programs,'' U.S. Treasury Department, December 24, 2010.
---------------------------------------------------------------------------
The reported bill also does nothing to increase the
accountability of Fannie Mae and Freddie Mac, nor those
operating them. The President has yet to nominate anyone to
officially run the FHFA, who acts as conservator, and the
Office of Special Inspector General of FHFA remains vacant.
Thus, there is no one politically accountable to the public for
the operation of these multi-trillion dollar entities. By
remaining silent on any interim taxpayer protections or
oversight provisions, the reported bill allows for the
continued unlimited bailout of Fannie Mae and Freddie Mac.
If nothing is to be done to address the future of the GSEs
in the reported bill, it would be useful to establish new
investigative oversight that would provide regular updates to
the Congress and to the American people. Limits governing the
taxpayer funding available to Fannie and Freddie and the
portfolio holdings of these institutions should be
reestablished. A process to ensure that future agreements of
this nature are approved by Congress also should be
established. Finally, a deadline should be given to the
President for the submission of a plan outlining his ideas for
the ultimate reform of Fannie Mae and Freddie Mac to ensure
that the timeline does not continue to slip.
Variation between the bill as reported and the specific changes to the
bill approved by Committee action
The reported bill contains numerous substantive changes
that were not approved by the Committee. Among these are:
1. Reducing the number of hours from 48 to 24 that
the Secretary has to provide a report to Congress
following the appointment of the FDIC as receiver for a
financial company (Section 203(c));
2. Removing the provision that made the consent of a
company's directors or shareholders to the appointment
of a receiver constitute a company being ``in default
or in danger of default'' (Section 203(c));
3. Prohibiting the FDIC from taking equity interest
in a covered financial company (Section 206);
4. Removing language that made liquidation of a
covered financial company optional and replacing it
with language that makes liquidation mandatory (Section
210);
5. Removing language that gave the FDIC the
discretion to put an institution into bankruptcy or
resolution if it defaulted on a debt guarantee provided
under Title VI and replacing it with language that
makes such action mandatory (Section 1156); and
6. Changing language to allow the Fed to lend to
``participants'' rather than ``programs'' under Section
13(3) of the Federal Reserve Act (Section 1151).
These are non-technical changes that should have been made
only through direct Committee action.
Conclusion
We are disappointed in the Committee's decision to report
the bill in its current form for Senate consideration. Even the
bill's proponents recognize that the reported bill is rife with
substantive and technical problems. We believe that the
reported bill's deficiencies are so significant that it will be
impossible to correct them on the Senate floor. We would
readily support a properly designed bi-
partisan financial reform bill. Unfortunately, the reported
bill is not such a bill. In fact, with respect to the bill's
treatment of the problems of too big to fail and bailouts, the
bill's language promises a future clouded with moral hazards in
financial markets, with unfair and undemocratic funding
advantages for a select few large financial institutions, and
with institutionalized bailout authorities. In the aftermath of
the economic crisis of 2008, we believe that it is the
responsibility of Congress to take action to prevent such a
crisis from occurring again. This bill not only fails in that
regard, it in fact makes future crises more likely.