This blog will make an attempt to look into the salient features of the comprehensive Financial Reform Bill that has been introduced in the Senate of the United States by Chairman Chris Dodd, Senate Committee on Banking, Housing and Urban Affairs last week with a view to restore American Financial Stability.

This bill aims at creating a sound economic foundation to grow jobs, protect consumers, rein in Wall Street, end too big to fail and prevent another financial crisis. This bill also attempts to restore responsibility and accountability in US Financial System.

Now let us look at the salient features of the bill.

INDEPENDENT CONSUMER FINANCIAL PROTECTION AGENCY

The bill proposes setting up of an independent consumer financial protection agency. Its sole job would be – protecting American consumers from fraud and abuse and ensuring they get clear information on loans and other financial products from credit card companies, mortgage brokers, banks and others. To put it simply, this Agency will be a sort of watchdog to oversee financial products. This ICFPA will consolidate the protection responsibilities currently handled by Office of Comptroller of the Currency, Office of Thrift Supervision, Federal Deposit Insurance Corporation, The Federal Reserve, the National Credit Union Administration and the Federal Trade Commission. It will be led by a five member board with an independent director. The Chairman of the Financial Institutions Regulatory Administration will have a seat on the board. With this Agency on the lookout for bad deals and schemes, consumers will be protected from bad business practices. This Agency will ensure that the level playing field for the banks by regulating the shadow banking industry players such as mortgage brokers and other lenders for the first time and make certain that companies offering the same products receive the same regulatory treatment.

FINANCIAL STABILITY AGENCY

The bill proposes creation of a new independent Agency for Financial Stability responsible for identifying, monitoring and addressing systemic risks posed by large, complex companies as well as products and activities that can spread risk across firms. It will discourage companies from getting too large by imposing burdens on them as they grow and give regulators the authority to break up large, complex companies if they pose a threat to the financial stability of the United States. Governed by an independent Chairman appointed by the President and confirmed by Senate to provide insulation from political manipulation, this agency will have nine members including the federal financial regulators and two independent members. The board members’ diverse areas of expertise will strengthen the agency’s ability to identify and respond to emerging risks throughout the financial system. This agency will write strict rules for capital, leverage, liquidity, risk management and other requirements as companies grow in size and complexity, imposing significant costs on companies that pose risks to the financial system. This agency is expected to be staffed with highly sophisticated staff of economists, accountants, lawyers, former supervisors and other specialists. With just rule writing authority and no direct supervision, the agency can remain small but effective. This agency will identify unregulated financial companies that post systemic risk and assign them to a federal regulator for supervision.

ENDING TOO BIG TO FAIL CONCEPT

The bill proposes to limit large, complex companies to prevent future bailouts. It proposes to impose increasingly strict standards for companies as they grow larger, more complex, or more interconnected, including heightened capital, leverage, and liquidity requirements that ensure these companies have greater resources to deal with financial shocks. The bill further proposes companies should provide their own capital injections that will provide them with liquidity during a systemic crisis so failing institutions can provide their own life support. The bill seeks large complex companies to periodically submit plans for their rapid and orderly shutdown should the company go under. Companies will be hit with higher capital requirements and subject to restrictions on growth and activity as well as required divestment if they fail to submit acceptable plans. These plans will help regulators understand the structure of the companies they oversee and serve as a road map for shutting them down if the company fails. The bill further seeks to create a mechanism for the FDIC to unwind failing systemically significant companies through receivership, but not open assistance. Costs of unwinding these companies will ultimately be charged to financial firms with assets over $10 billion and not to the tax payers.

FINANCIAL INSTITUTION REGULATORY ADMINISTRATION

The bill proposes to set up a Financial Institution Regulatory Administration headed by an independent chairman appointed by the President and confirmed by the Senate, a vice chairman experienced in state banking regulation and a board including the chairmen of FDIC and the Federal Reserve and two independent members. It will be funded primarily by assessments on the industry. This single focused agency combines the functions of office of Comptroller of the Currency and the office of Thrift Savings, the state bank supervisory functions of Federal Deposit Insurance Corporation and the Federal Reserve and the bank holding company supervision authority from the Federal Reserve. The bill proposes to preserve the dual banking system leaving in place the state banking system that governs most of the nation’s community banks. The bill proposes to establish a separate division within the new regulator to regulate community banks given the different supervisory issues they pose. The bill will thus stop financial institutions from choosing the easiest regulator and stop fee funded regulators from going easy on those they regulate to keep their business. Having a single regulator will mean an identifiable agency is held responsible for shortcomings in the banking system. The bill will seek to end slow, cumbersome, coordinated rulemaking that creates extra red tape and inconsistent enforcement of the same rules by agencies. In the proposed process, the FDIC will focus on its jobs as deposit insurer and resolver of failed institutions, retaining back up examination authority over troubled banks and gaining additional authority to accompany the new agency on examinations of healthy banks and holding companies to ensure it has sufficient information to perform its insurance functions. The Federal Reserve will focus on monetary policy without being distracted by responsibilities for bank oversight and consumer protections. The Federal Reserve will continue to play a key role in assessing financial stability and have guaranteed access to financial institutions and any needed information.

TRANSPARENCY AND ACCOUNTABILITY IN THE DERIVATIVES MARKET

The bill proposes to provide the SEC and CFTC with authority to regulate over the counter derivatives so that irresponsible practices and excessive risk taking can no longer escape regulatory oversight. The bill proposes to use the above Administration’s outline for a joint rule making process with the Agency for Financial Stability stepping in if the two agencies can’t agree. The bill requires central clearing and exchange trading for derivatives that can be cleared and provides a role for both regulators and clearing houses to determine which contracts should be cleared. The bill proposes that the SEC and CFTC to pre approve contracts before clearing houses can clear them. To safeguard un cleared trades, the Bill proposes to require traders post margin and capital on un cleared trades in order to offset the greater risk they pose to the financial system and encourage more trading to take place in transparent, regulated markets. Towards market transparency, the bill proposes data collection and publication through clearing houses or swap repositories to improve market transparency and provide regulators important tools for monitoring and responding to risks.

RAISING STANDARDS AND REGUALTING HEDGE FUNDS

The bill proposes to end the shadow financial system in which hedge funds and other private pools of capital operate by requiring that they provide regulators with critical information. The bill requires hedge funds to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk. This data will be shared with the system risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity. The bill proposes these investment advisers should use independent custodians for client assets to prevent Madoff type frauds. To facilitate greater State supervision, the bill proposes to raise the assets threshold for federal regulation of investment advisers from $25 million to $100 million, a move expected to increase the number of advisors under state supervision by 28%. States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.

STREAMLINE INSURANCE REGULATION

The bill proposes to create a new office within the Treasury Department to monitor the insurance industry, coordinate international issues and requires a study on ways to modernize insurance regulation and provide Congress with recommendations. The bill proposes to streamline the regulation of surplus lines insurance and reinsurance through state based reforms.

OVERSIGHT OF CREDIT RATING AGENCIES

The bill proposes to create an office of Credit Ratings at the SEC with its own compliance staff and the authority to fine agencies. The SEC is required to examine Nationally Recognized Statistical Ratings Organizations at least once a year and make key findings public. The bill requires the NRSRO to disclose their methodologies, their use of third parties for due diligence efforts, and their ratings track record. The bill further requires agencies to consider information in their ratings that comes to their attention from a source other than the organizations being rated if they find it credible. The bill prohibits compliance officers from working on ratings, methodologies or sales. Under this bill, the investors could bring private rights of action against rating agencies for a knowing or reckless failure to investigate or to obtain analysis from an independent source. The bill will empower the SEC the authority to deregister an agency for providing bad ratings over time. The bill proposes the ratings analysts to pass qualifying examinations and have continuing education.

STRENGTHEN SHAREHOLDER RIGHTS ON EXECUTIVE COMPENSATION

The bill proposes to empower the shareholders a say on pay with the right to a non binding vote on executive pay and golden parachutes linked to corporate takeovers. This will provide the shareholders a powerful opportunity to hold accountable executives of the companies they own, and a chance to disapprove where they see the kind of misguided incentive schemes that threatened individual companies and in turn the broader economy. The bill proposes to provide shareholders proxy access to nominate directors. Providing shareholders a greater role in choosing directors can help shift management’s focus from short term profits to long term growth and stability. The bill further seeks set up of Independent Compensation Committees with only independent directors with authority to hire compensation consultants to strengthen their independence from the executives they are rewarding or punishing. The bill proposes to set policies to take back executive compensation if it was based on inaccurate financial statements that don’t comply with accounting standards. The bill will seek to direct the SEC to clarify disclosures relating to compensation, including requiring companies to provide charts that compare their executive compensation with stock performance over a five year period.

IMPROVING INVESTOR PROTECTIONS

The bill proposes to mandate an annual assessment of SEC’s internal supervisory controls and a biannual GAO study of SEC management. The bill also proposes to mandate uniform standards for any one providing customer’s investment advice, eliminating different standards for broker dealers and investment advisers. Small investors should have uniform protection regardless of the title of the financial professional advising them. The bill seeks brokers who give investment advice will be held to the same fiduciary standard as investment advisers – they will be required to act in their clients’ best interest. Investors will be enabled to sue persons who help commit securities fraud. The bill proposes to create the Investment Advisory Committee, a committee of investors to advice the SEC on its regulatory priorities and practices as well as the Office of Investor Advocate in the SEC, to identify areas where investors have significant problems dealing with the SEC and FINRA and provide them assistance. The bill further proposes the self funded SEC will no longer be subject to the annual appropriations process.

REDUCING RISKS POSED BY SECURITIES

The bill proposes the companies that sell products like mortgage backed securities to retain at least 10% of the credit risk. That way if the investment doesn’t pan out, the company that made, packaged and sold the investment would lose out right along with the people they sold it to. The bill will require issuers to disclose more information about the underlying assets and to analyze the quality of the underlying assets.

BETTER OVERSIGHT OF MUNICIPAL SECURITIES

The bill will require SEC registration for financial advisers, swap advisers and investment brokers – unregulated intermediaries who play key roles in the municipal bond market. The bill proposes to subject financial advisers, swaps advisers and investment brokers to rules issues by the Municipal Securities Rulemaking Board and enforced by the SEC or a designee. The bill proposes to give investor and public representatives a majority on the MSRB to better protect investors in the municipal securities market where there has been less transparency than in corporate debt market.

In a nutshell, the bill proposes to create three new agencies – Financial Institutions Regulatory Administration, Agency for Financial Stability and Consumer Financial Protection Agency.

Let us look forward to the debates and decisions by the Senate on this bill.