From the Eisner LLP Legislative Monitoring Group

Background

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) which provides, among other matters, for increased regulation of banks and other financial institutions and creates a Financial Stability Oversight Council.

In this release, we comment on the increased regulation of financial institutions – referred to in the Act as Financial Institution Stability Improvement Provisions – which will impact how financial institutions do business and increase their governmental reporting.

Financial Institution Stability Improvement Provisions of the Act

General Purposes & Approach

The Financial Institution Stability Improvement Provisions generally require more oversight of financial institutions, increase the financial institutions subject to oversight to include foreign banks and other financial firms not previously subject to regulation, and require more capitalization of financial institutions. Congress is to be advised on accounting developments as well as financial issues. A framework for coordinating regulatory agencies is established.

A.   Oversight

The Financial Services Oversight Council (FSOC) is to be established, with voting members being representatives of the major federal financial regulatory bodies, chaired by the Secretary of the Treasury. The President will also appoint a representative familiar with insurance. In addition, state banking and insurance regulatory representatives may be non-voting members. The FSOC will advise Congress and recommend measures to enhance efficiency, competitiveness, and stability of the U.S. financial markets and to reduce systemic risk.

Other financial institution regulatory boards are strengthened. The Federal Reserve Board has increased powers to require “stress tests” on financial institutions and require large complex financial institutions to develop liquidation plans which must be periodically updated. It can also address systemic risks of foreign banks and increase regulation of foreign banks.

Observation: The FSOC will have tremendous power to require reporting from financial institutions, and for the first time the federal government will have legislative authority to monitor insurance companies, traditionally regulated by the various states. The FSOC will also have authority over non-bank financial companies, including private equity funds and hedge funds.

Observation: Aside from FSOC oversight of such funds, the Private Fund Investment Advisers Registration provisions of the Act require most hedge fund and private fund advisers to register with the Securities and Exchange Commission and implement compliance measures such as tapping a chief compliance officer, developing a written code of ethics and implementing policies to curb insider trading.

By contrast to such potential federal regulatory restrictions, the Act also enables national or state banks to open branches in other states as if they were chartered in those states.

B.  Capitalization

The Federal Reserve Board is directed to require financial holding companies to meet a 15:1 debt-to-equity leverage requirement. Also, short term borrowings by such a company can be limited and guaranteed debt can be limited to $500 billion. Sales of asset backed securities will require creditors and syndicators to maintain a portion of the credit risk on the receivables sold. Many forms of capital, such as trust preferred certificates, will no longer be counted as capital.

Observation: Increased capitalization limits on financial institutions may result in banks being more cautious with lending or restricted in raising additional capital. Limitations on securitizations will reduce options for banks to improve their balance sheets.

C.  Securities Trading and Investment

Banks generally will be subject to regulatory restrictions on trading for their own account, and on investing in hedge and private equity funds. Non-bank holding companies engaging in trading for their own account will be subject to greater capitalization requirements.

Observation: More trading activities may be shifted to independent hedge funds if professionals find employment at banks less attractive.

D.  FDIC Changes

The Federal Deposit Insurance Corporation will be able to seek bankruptcy of an insured bank and its claims will have preference over unsecured claims. It can require more reports from banks and can receive warrants or other financial instruments from them.

Observation: Lenders to banks may become more conservative.

E.  Derivatives

The Securities and Exchange Commission and the Commodities Futures Trading Commission are to consult on further regulation of derivatives instruments.

Observation: Additional reporting and collateral requirements may be imposed.  In addition, any authority of the Federal Energy Regulatory Commission over energy-related financial and other matters is not altered by the Act.

F.  Executive Compensation

A non-binding shareholder vote is required on executive compensation of a publicly traded financial institution.

General Observation: Bank of America, among the largest U.S. financial institutions, has estimated that the Act’s rules could cost it as much as $4.3 billion per year in lost revenue and a one-time charge of $7-10 billion. On the other hand, small banks apparently escape many of the regulations.

Conclusion

Regulations to implement the key Financial Institution Stability Improvements Provisions of the Act will be developed over a fairly lengthy period, reflecting varying effective dates for different provisions and allowing in many cases a transition period for affected institutions to meet new requirements.

If you wish to discuss financial implications or related aspects of these provisions, please contact Eisner or email swittner@eisnerllp.com. In addition, you are strongly urged to consult qualified legal and other professional advisers to learn the full impact of the Act.