At long last, Senate Banking Committee Chairman Christopher Dodd (D-CT) has released new draft legislation for overhauling the nation’s financial regulatory system. A summary of the legislation is available here.
We’ll be going over the bill with a fine-tooth comb over the next few days, but here are some initial thoughts:
As had been widely speculated, the bill would create a Consumer Financial Protection Bureau within the Federal Reserve. Among other things, the Bureau will have an independent director appointed by the President, and will have the authority to examine and enforce regulations for banks and credit unions with assets over $10 billion as well as other mortgage-related businesses and non-bank financial companies. However, other regulators would have the authority to appeal the Bureau’s regulations if they believe the rules would endanger the safety and soundness of the banking system or the stability of financial markets. House Financial Services Committee Chairman Barney Frank (D-MA) recently said that the idea of housing a consumer protection agency inside the Fed is like a “bad joke,” but it appears that Elizabeth Warren—chair of the Congressional Oversight Panel and a long-time advocate of consumer protections—is open to the idea.
Other proposed initiatives that are likely to generate heated debate in the next few weeks include the creation of a Financial Stability Oversight Council—chaired by the Treasury Secretary and made up of other regulators from the SEC, FDIC, etc.—that would be responsible for monitoring systemic risk. The Council could vote to require that the Fed regulate non-bank financial companies that pose systemic risks (think AIG), and would also be able to approve decisions allowing the Fed to break up large, systemically risky companies. The bill also gives a nod to the White House’s proposed Volcker Rule by requiring regulators to implement rules prohibiting proprietary and hedge fund trading by banks, their affiliates, and bank holding companies, but adds that regulations will only be implemented after a study conducted by the Financial Stability Oversight Council. In addition, the bill would levy $50 billion in fees on the largest financial firms to cover the cost of dissolving failing companies in the future.
But while these sections are the ones that will likely generate the most media and congressional attention in the weeks to come, there are other provisions in the bill that could also have far-reaching consequences for the future of financial regulation, including some sections that will be of particular interest to readers of this blog.
At first glance, the bill appears to include some very sensible reforms for the SEC. For instance, it would create a program similar to the False Claims Act and the IRS whistleblower bounty program to encourage people to come forward with reports of securities violations, allowing them to keep between 10 and 30 percent of the funds recovered. It would also prohibit employers from retaliating against whistleblowers who lawfully provide the SEC with reports of securities violations, and would allow whistleblowers who were retaliated against to bring court action for relief, including reinstatement and backpay. The SEC’s mishandling of whistleblower complaints—including its inability to stop the Madoff Ponzi scheme despite receiving multiple tips from Harry Markopolos—has come under sharp criticism in recent years, and we applaud Congress for taking steps to protect whistleblowers and the investing public.
The bill would also create a new Office of Credit Ratings at the SEC to examine credit rating agencies, with the authority to fine or even deregister an agency for providing bad ratings, although there are concerns that these reforms might not be enough to address the rampant conflicts of interest resulting from the fact that the agencies get paid by the companies they rate.
We were encouraged to see that the bill includes language enabling the Government Accountability Office (GAO) to audit any emergency lending facility set up by the Fed under its 13(3) authority, a measure we supported in the House’s bill. We were also pleased to see a provision that would address conflicts of interest in the governance of Federal Reserve Banks by prohibiting past or present officers, directors, and employees of Fed-supervised companies from serving as directors.
One big question mark still hovers over the section of the bill that deals with the regulation of over-the-counter derivatives. The bill summary states that “Senators Jack Reed (D-RI) and Judd Gregg (R-NH) are working on a substitute amendment to this title that may be offered at full committee.” But in the meantime, the bill introduced today largely reflects language introduced in an earlier draft. For instance, it includes a provision that would create an “alternative swap execution facility” defined as “an electronic trading system with pre-trade and post-trade transparency in which multiple participants have the ability to execute or trade swaps by accepting bids and offers made by other participants that are open to multiple participants in the system, but which is not an exchange.” POGO had raised concerns about similar language in the House’s bill since it appears to undermine the goal of moving as much trading as possible to well-regulated and transparent exchanges and clearing houses.
It will also be interesting to see how the substitute amendment deals with the issue of so-called “end-users”: non-financial sector companies, municipalities and non-profits that use derivatives as a standard business practice to hedge against risk. According to the Congressional Research Service, a broad end-user exemption from the bill’s clearing requirement could leave many swaps in the dark, and Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler has been arguing that opacity in the over-the-counter derivatives market mostly benefits the large broker-dealers (Goldman Sachs, JPMorgan, etc.) rather than the end-users.
POGO also remains concerned that Congress is not adequately addressing the lack of transparency, conflicts of interest, and weak enforcement record at self-regulatory organizations such as the Financial Industry Regulatory Authority (FINRA). And even if the bill does fill some of the regulatory gaps that were exposed by the financial meltdown, there is still the problem of agencies that have all the authority they need but are still unduly influenced by the industry they’re tasked with regulating.
Stay tuned in the weeks ahead, as POGO will be analyzing the Senate’s bill in much greater detail and will be offering more of our own proposals for fixing the financial regulatory system.
-- Michael Smallberg