The Dodd-Frank Act, also known as the Wall Street Consumer Protection Act, was signed into law July 21, 2010 as a response to the financial meltdown that required the bank bailouts of 2008 and 2009. Coming in at over 2,300 pages and containing 240 rulemaking provisions, its changes in America’s financial regulatory environment affect all federal financial regulatory agencies and almost every part of the financial services industry.
How does the Dodd-Frank Act affect your business? As of now, only one part of the Dodd-Frank Act, the Durbin Amendment, directly affects small businesses. Prior to Dodd-Frank, debit card transaction fees were 44 cents; Visa and MasterCard used their Merchant Agreements to forbid minimum limits on credit cards transactions and discounts for cash. The Durbin Amendment lowered debit card transaction fees for small businesses in several ways:
While these changes result in savings for most small businesses, there has been one negative effect. In the past, Visa and MasterCard discounted transactions under $10; both companies have stopped, citing the need to make up the revenue lost under the new guidelines.
The remainder of the Dodd-Frank Act is concerned with regulating and overseeing financial institutions. Please read below for the specifics of the Act:
Financial Stability Oversight Council The Dodd-Frank Act created the Financial Stability Oversight Council to oversee financial institutions and the government agencies that regulate them. The council is charged with identifying threats to the stability of the financial system, promoting market discipline, and responding to emerging risks. The council brings together members from various financial regulators including the U.S. Securities and Exchange Commission (SEC), the Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC) and the U.S. Commodity Futures Trading Commission (CFTC), to discuss and share information.
The Consumer Financial Protection Bureau (CFPB) The Consumer Financial Protection Bureau (CFPB) was established by the Dodd-Frank Act as an internal watchdog to regulate consumer financial products and services. The CFPB seeks to stop risky lending practices that may hurt borrowers. The CFPB operates a hotline to give consumers advice and access to unbiased mortgage information and credit control scores.
Orderly Liquidation Authority Dodd-Frank consumer protections seek to prevent another “too big to fail” situation. The largest financial companies will be required to submit “living wills” to regulators in case of financial failing. The Dodd-Frank Act empowers the FDIC to assume control of liquidating any bank or other financial institution that is failing and poses a significant risk to financial stability upon its failure. If the FDIC needs money to pay for the liquidation process, the FDIC can assess the larger financial companies for the additional money, as no taxpayer funds are to be used for the company’s liquidation.
Derivatives Regulation Derivatives are financial instruments derived from another underlying asset, security or index. The Dodd-Frank Act enacts measures for reporting, clearing, trading and record-keeping swap derivatives. In July the CFTC and SEC laid out when interest-rate, credit, commodity and other derivatives are considered swaps. This activated Dodd-Frank Act rules increasing collateral requirements and bringing transparency to these markets by requiring registration and interest-rate and credit swap reporting. The Lincoln Provision, also known as the “Swaps Pushout” rule provides that after a transition period, no “Federal assistance” may be provided to any swaps entity.
Regulation of Hedge Funds The Act seeks to regulate hedge funds and other private funds, by requiring registration and regular reporting of many of the funds that previously operated under an exemption from reporting to the SEC. The SEC will require hedge funds managing over $100 million to be registered as investment advisers.
Investor Protection Reform The Dodd-Frank Act aims to increase investor protection. It empowers the SEC to establish a fiduciary standard for broker-dealers that provide personalized investment services and to facilitate clear investor disclosure of broker-dealers’ and investment advisers’ relationships and conflicts of interest. The Act prohibits or limits use of mandatory arbitration and mandates studies on various financial practices including short selling, conflicts of interest involving analysts, and feasibility of a self-regulatory organization to oversee private funds. It changes the accredited investor standard to exclude the value of an investor’s primary residence and provides for special protection of senior investors.
Whistleblower Protection A provision included in Dodd-Frank ensures that anyone who has knowledge that a company is committing fraud can report the crime and receive compensation for doing so. Whistleblowers can receive 10-30% of the fees recovered as long as it is in excess of one million dollars.
Credit Rating Agency Reform The Dodd-Frank Act stipulates that credit rating agencies (CRAs) must: include reports with credit ratings that explain representations, warranties and enforcement mechanisms available to investors and how they differ from similar issuances; disclose information on initial ratings and subsequent changes; establish an effective internal control structure; and submit annual reports to the SEC. The Act establishes that CRAs have a duty to report violations of law to appropriate authorities. At least half of CRAs’ boards of directors are required to be independent directors who serve a fixed term, with a portion of the directors being users of ratings.
The Volker Rule The Volker Rule provisions impose a prohibition on most proprietary trading by U.S. banks and their affiliates. They restrict covered financial institutions from owning, sponsoring, or investing in hedge funds or private equity funds, subject to limited exceptions.
“Say-on-Pay” A provision of Dodd-Frank establishes that companies must include a resolution in their proxy statements asking shareholders of companies to approve compensation of named executive officers in a non-binding vote. A proxy statement on a “Say in-on-Golden Parachute” vote needs to include “clear and simple” disclosure of the golden parachute arrangements.
Enhanced Compensation Disclosure Disclosure is required of the compensation paid to executives versus the company’s financial performance.
Capital Requirements The Dodd-Frank Act imposes more stringent regulatory capital requirements on financial institutions. The Collins Amendment Provisions require the establishment of minimum leverage and risk-based SOE capital requirements. Several studies, due within the next two years, will further impact capital requirements.
Regulation of SEC Matters Part of the Dodd-Frank Act concerns the SEC and matters regulated by it. The Act increases the influence of investors by creating an Office of the Investor Advocate and an Investor Advisory Committee. SEC’s role in regulating credit rating agencies is increased as is the regulation of asset-backed securities (including mortgage-backed securities).
The full extent of the impact of the Dodd-Frank Act remains to be seen. As mandated studies are completed, more provisions of the Act will be activated. While Dodd-Frank strives to make the economy and country safe from the threat of a wide-scale financial crisis, some sources speculate that the continuing implementation of Dodd-Frank could lead to tightening of loans for small businesses.