Dodd-Frank One Year Later: A Lot of Unfinished Business

The one-year anniversary of the Dodd-Frank Act (DFA) marks an important moment to review and reflect on the transformative changes that have taken place since enactment of the sweeping reforms.  Yet, much of the work to implement those reforms is still underway.A slew of reports and studies were released to recognize the significant milestone, and of which there are a few worth reviewing:

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Transparent Oil: New Dodd-Frank Requirements

Written by Anderson Franco & Angélica Salceda

Theoil industryhas recently criticized the Dodd-Frank Act’s oil and gas reporting rules by claiming that the transparency requirements will result in restrained money flows between oil companies and governments.  Under Dodd-Frank, all oil, gas and mining companies registered with the SEC must report payments to foreign governments on a country-by-country, and project-by-project basis.

The transparency requirements will provide detailed, standardized, and comparable data that will pressure governments to improve their revenue reports and strengthen oversight.  Critics claim that the disclosures required by Dodd-Frank undermine the voluntary standard established by theExtractive Industries Transparency Initiative(EITI).

TheEITIis a global standard that promotes revenue transparency and provides a methodology for monitoring and reconciling company payments and government revenues. Nevertheless, only 11 of the 35 EITIimplementing countries fully comply with the requirements.

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SEC Rolls Out the “Skin in the Game” Regulation to Mitigate Moral Hazard for Lenders and Bond Issuers Involved in Asset-Backed Securities

On March 31 the SEC began seeking public comment on its proposed “skin in the game” regulation, which would require lenders and bond issuers of asset-backed securities (ABS’s) to retain 5% of the credit risk of the securities they issue. This requirement would apply to each of the tiers of ABS’s issued individually, preventing a lender or bond issuer from issuing a large proportion of risky securities and yet only retaining its 5% stake in those safer, higher-grade securities it issues. In the alternative, a lender or bond issuer could also comply with the regulation by retaining 5% of the first-loss residual interest of all ABS’s issued or a 5% interest in a representative sample of the underlying securities.

The rule is one of the many proposed by the SEC in accordance with the mandates of the Dodd-Frank Act. The rule was motivated by the public perception that there was an incentive problem, often referred to as a moral hazard, inherent in lending practice that became hegemonic in the mortgaged-backed securities (MBS’s) market. The potential problem lies in the fact that the banks and lenders extending loans to home buyers may not fully appreciate the credit risk of doing so because of their ability to turn around and easily sell these mortgages on the secondary market (commonly referred to as the “originate-and-distribute” model). Large financial institutions, acting as intermediaries between these lenders and investors, would buy mortgages and combine many of them into an investment tool, dividing the pool of mortgages into traunches (with returns on investment commensurate with the perceived security of the traunch invested in). While this securitization process is effective at providing greater liquidity in the mortgage market (as more investors will be willing to invest in the industry if the risk of default can be managed and mitigated through diversification and stratification inherent in the securitization process) the process also debased the incentive for lenders and bond issuers to ensure that borrowers were truly credit-worthy and able to sustain their mortgage payments.

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Don’t Count Me In: Firms Scramble to Avoid Making the “Systemically Important” List

As reported in a previous post on this forum (see Fed Proposes Definitions for Systemically Important Nonbank Financial Institutions) the Fed proposed a rule on February 8th regarding when a company would be considered “systemically important.” This rule is significant because the designation would be accompanied by a large number of regulatory requirements (which would be accompanied by increased compliance costs), including the ominous authority/responsibility the FDIC will have to “wind down” the company in the event it nears failure.

Financial institutions are now engaged in a major lobbying effort to shape the definition of systemically important institutions in order to avoid the accompanying regulatory requirements. The decision is left up to the Financial Stability Oversight Council, which is scheduled to discuss this issue at its next meeting in May. Large bank holding companies, such as Bank of America, are clearly set to come under the umbrella of the regulation, due to the size of the assets they control (greater than $50 billion). However, insurance companies that fall under this threshold are looking to avoid the list, arguing that they do not present the same systemic risks that banks do because they are not susceptible to a run on their assets.

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Let the Delegation Continue: Supreme Court Reaffirms Deference to Administrative Agencies in Regulatory “Interpretation” of Statutes

On January 11th the Supreme Court handed down its decision in Mayo v. U.S. The decision reaffirmed the Court’s use of the Chevron standard, under which government agencies are given broad authority to make any “reasonable interpretations” of statutes so long as Congress does not specifically and clearly address the issue in the relevant legislation. The decision is significant because lower courts had previously spliton whether the Treasury Department, in implementing the Internal Revenue Code (IRC), was subject to the more exacting standard found in National Muffler. Under the National Muffler standard, government agencies’ only had the latitude to make interpretations that “harmonize with the plain language of a statute, its origin, and its purpose.”

In Mayo v. U.S. the plaintiff, Mayo Foundation for Medical Education and Research, was challenging a Treasury Department regulation that would classify medical residents (individuals that have recently graduated from medical school and seek additional instruction in a specialization) as employees. The Treasury Department implemented this regulation pursuant to a statutepassed by Congress, which exempted from consideration as employees individuals whose “services performed in the employ of… a school, college, or university… if such service is performed by a student that is enrolled and regularly attending classes at [the school].” Dating back to 1951 the Treasury Department had exempted students (including medical residents) from being classified as employees of schools, colleges, and universities, if their work was “incident to and for the purpose of pursuing a course of study.” However in 2004 the Treasury Department passed a regulationthat eliminated this exemption for “students” that worked 40 hours per week or more. Utilizing the Chevron standard, the Court in Mayo concluded that it was reasonable for the Treasury Department to change course and consider individuals working 40 hours or more per week as not “regularly attending classes.”

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What’s at Stake in the Ongoing Mortgage Servicing Settlement Negotiations?

Potentially $135 billion or the political demise of the CFPB.

Ahead of the first face-to-face negotiations between major banks and government agencies over a proposed mortgage servicing settlement, additional information is surfacing over the potential scope and scale of the settlement.  An internal presentation by the CFPB to the 50-state Attorneys Generals estimates that mortgage servicers avoided $20 billion in servicing costs by failing to adequately process loan modifications of troubled homeowners, and suggests that a proposed settlement, in addition to or as an alternative to a regulator-imposed penalty, would focus on mandates for principal reduction and short sales for underwater homeowners.

The CFPB estimates that a regulator-proposed $20 billion penalty would have limited effect on the bank’s capital ratios, suggesting that a penalty that size would not adversely affect bank solvency.   However, depending on the extent of borrower eligibility for principal reductions (i.e., how much principal is forgiven) and the number of mandated loan modifications, these mandates could cost servicers and banks anywhere between $7 billion to $135 billion.  It is unclear whether the major servicer banks could absorb a settlement costing $135 billion, although some have already speculated that the true costs could go beyond these estimates.

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And the Winner Is: Annual Voting on Executive Compensation

As reported in February, the Securities and Exchange Commission (SEC) issued final rules regarding the Dodd-Frank’s so-called say-on-pay provision in January. The new rule requires SEC filing companies to allow shareholders to have an advisory vote on executive compensation as well as an advisory vote on how frequently shareholders will vote on executive compensation. Shareholders now have the choice to vote on executive compensation in one, two, or three-year intervals. Now, two months later, Form 8-K filing statistics show that more companies are endorsing annual voting than earlier in the seasons, and shareholders are showing a clear preference for the annual voting schedule.

To date, 105 of the 173 large-cap S&P 500 firms have filed proxy materials endorsing annual say-on-pay voting, while only 56 have filed materials endorsing the triennial schedule. A mere seven firms have endorsed biennial voting, and five firms have made no recommendation. In addition, of the 417 Russell 3000 firms that have filed, 210 have supported annual voting – a marked increase from earlier Russell 3000 company filings – 182 advocated triennial voting, 13 recommended biennial voting, and 12 made no recommendation.

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Live Blogging at the Dodd-Frank Symposium: Understanding the Structure and Role of the Consumer Financial Protection Bureau

Gail Hillebrand of the Consumer Union just delivered a clear and concise explanation of the statutory structure of the newly created Consumer Financial Protection Bureau. Ms. Hillebrand discussed the types of products, services, and providers within the purview of CFPB jurisdiction. She also explained the new powers and obligations of the agency, its role in supervision of certain financial institutions, and how its existence will affect the distribution of power among existing federal agencies. Of particular interest in this new statutory structure, is the ability of states to have a much greater role in consumer protection regulation.

View Ms. Hillebrand’s slide show here.

Live Blogging at the Dodd-Frank Symposium: The Power of Disclosure

Thomas Brown of O’Melveny & Meyers just spoke about the interest of consumers and financial institutions on the new Consumer Financial Protection Bureau’s ability to regulate the disclosure of financial products to customers. Mr. Brown argues that such power would allow the CFPB to reshape the landscape of the industry. Mr. Brown spoke on the new “fully, accurately, and effectively disclosed” standard, a standard that is quite different than “not false and misleading.” Mr. Brown also brought to the fore three pertinent questions regarding this new disclosure standard:

1) Who must be permitted to understand?
2) What defines the universe of things that must be understood?
3) What does “permit to understand” mean?

To view Mr. Brown’s working paper click here.

Live Blogging at the Dodd-Frank Symposium: Dodd-Frank’s New Ability to Pay Provision

Professor John Pottow of the University of Michigan School of Law, just addressed Dodd-Frank’s newly created duty of lenders to assess and assure a borrowers ability to pay.  As Professor Pottow pointed out, such a concept is not wholly new to legal thought; however, Dodd-Frank’s wholesale import of the standard is a radical change to U.S. consumer law. Professor Pottow reviewed the geneology of the law as well as comparing it to similar concepts in other areas of domestic law and similar foreign laws. In addition, Professor Pottow also parsed the language of the new ability to pay statute and discussed worries regarding how this new duty will be interpreted.

To view Professor Pottow’s full working paper click here.