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