As pundits pore over the accomplishments and shortcomings of President Donald Trump’s first 100 days in office, regulatory reform will undoubtedly be a focus. Eight days shy of the administration milestone, the boldest moves yet for the world of financial regulations materialized.
“We’ve lifted one terrible regulation after another at a record clip, from the energy sector to the auto sector,” Trump said during an April 21 speech. “We have many more to go.” The comments preceded his strongest punch yet at the Dodd-Frank Act, specifically two of its most controversial creations.
“I’m issuing two directives that instruct Treasury Secretary Steven Mnuchin to review the damaging Dodd-Frank regulations that failed to hold Wall Street firms accountable. I mean, they’ve done really, in many cases, the opposite of what they were supposed to,” Trump said. “These regulations enshrine ‘too big to fail’ and encourage risky behavior.”
One of the presidential memorandums addressed Dodd-Frank’s Title II, which established an Orderly Liquidation Authority to oversee the winding down of failed, systemically important financial institutions.
Using OLA, the Secretary of the Treasury may place a financial company in receivership and initiate liquidation after making a determination that it is in default or in danger of default, and its failure and resolution under otherwise applicable law would have serious adverse effects on financial stability in the United States.
“The existence of OLA may encourage excessive risk taking by creditors, counterparties, and shareholders of financial companies,” the Trump memorandum warns, “because the legislation also created an Orderly Liquidation Fund, housed in the Treasury Department, that is authorized to use taxpayer funds to carry out OLA liquidations.”
The memorandum adds that because OLA provides a government backstop to shield creditors, counterparties, and shareholders from excessive financial losses, it may encourage reckless risk taking and poor market discipline.
Trump directed Secretary Mnuchin to conduct a review of OLA that considers: whether invoking it could result in a cost to the general fund of the Treasury; and whether it could lead to excessive risk-taking on the part of creditors, counterparties, and shareholders, or otherwise lead market participants to believe that a financial company is “too big to fail.”
The report, due 180 days after the announcement, will also address whether a new chapter in the U.S. Bankruptcy Code, under which the claims against a failed financial company would be resolved pursuant to the procedures of bankruptcy law rather than the Dodd-Frank Act, “would be a superior method.”
A second memorandum issued on April 21, takes aim at the Financial Stability Oversight Council. Comprised of the heads of financial regulators, the FSOC is, among other things, tasked with assessing whether banks and non-banks are sufficiently large and substantially interconnected to pose a threat to the financial stability of the United States were they to fail.
“Just as we should be holding companies to a really high standard to encourage and foster transparency, if anyone is asked to do something that is wrong they have a duty to step up and say that something isn’t right.”
Gregory Keating Chairman, Whistleblower Defense Group, Choate Hall & Stewart
If the FSOC makes the determination that an institution is a SIFI (systemically important financial institution), the entity is subject to supervision by the Board of Governors of the Federal Reserve System and heightened prudential standards.
“It is important to ensure that these processes for making determinations and designations promote market discipline and reduce systemic risk,” the memorandum says. “It is equally important to ensure that, once notified by the FSOC that it is under review, any entity under consideration for a determination or designation decision is afforded due, fair, and appropriately transparent process.”
The Treasury secretary is directed to conduct a thorough review of the FSOC designation processes. The review will consider whether they are sufficiently transparent and offer adequate due process. The analysis should also consider whether a non-bank financial company’s SIFI designation should include specific, quantifiable projections of the damage that could be caused to the economy.
Another topic to explore: whether firms have a meaningful opportunity for designations to be “reevaluated in a timely and appropriately transparent manner.”
Pending the completion of the required review, the Treasury Secretary may not vote for any non-emergency proposed determinations or designations.
Financial Services Committee Chairman Jeb Hensarling (R-Texas) was among those praising the presidential decrees.
President Trump, he said, “pledged to dismantle Dodd-Frank” and his actions “are another significant step towards ending the mistake that has given Washington bureaucrats more power to politically control our economy.”
Hensarling proceeded to use the President’s actions to promote the Financial CHOICE Act, a legislative package he developed that is now in its second iteration and includes hundreds of pages of Dodd-Frank revisions. A few of the many changes up for Congressional consideration in the Financial CHOICE Act include:
Repealing the FSOC’s authority to designate “financial market utilities” as systemically important;
Abolishing the Federal Reserve’s authority to supervise and set regulations for non-bank financial institutions;
Improving the stress testing process for bank holding companies;
Increasing the civil money penalties that may be sought in administrative and civil actions brought by the Securities and Exchange Commission;
Requiring proxy advisory firms to register with the SEC;
Renaming the Consumer Financial Protection Bureau as the Consumer Law Enforcement Agency, with a deputy director appointed by the president and removable at will;
Directing the SEC to publish a manual establishing its enforcement policies and procedures; and
Allowing banks and credit unions to qualify for regulatory relief if they maintain sufficient capital levels so as to not require a taxpayer bailout.
“Regulatory burden relief is very complicated, particularly post-Dodd-Frank,” says Oliver Ireland, a partner at law firm Morrison Foerster. “You ask, ‘Maybe I should get rid of all that stuff.’ Then you start to think, ‘What I really need to do is look for where the problems are and prioritize those problems.’ ”
Memorandum on FSOC
The following is from President Donald J. Trump’s memorandum to the Treasury Secretary regarding the Financial Stability Oversight Council.
By the authority vested in me as President by the Constitution and the laws of the United States of America, and to promote certainty in the financial markets, I hereby direct the Secretary of the Treasury (Secretary) to take the following actions:
Section 1. Report on FSOC Processes. The Secretary shall conduct a thorough review of the FSOC determination and designation processes under section 113 (12 U.S.C. 5323) and section 804 (12 U.S.C. 5463) of the Dodd-Frank Act and provide a written report to the President within 180 days of the date of this memorandum. As part of this review, and along with any other considerations that the Secretary deems appropriate, the Secretary shall consider the following:
(a) whether these processes are sufficiently transparent;
(b) whether these processes provide entities with adequate due process;
(c) whether these processes give market participants the expectation that the Federal Government will shield supervised or designated entities from bankruptcy;
(d) whether evaluation of a nonbank financial company's vulnerability to material financial distress, under 12 CFR 1310 App. A.II.d.1, should assess the likelihood of such distress;
(e) whether any determination as to whether a nonbank financial company's material financial distress could threaten the financial stability of the United States, under 12 CFR 1310 App. A.II.a, should include specific, quantifiable projections of the damage that could be caused to the United States economy, including a specific quantification of estimated losses that would be likely if the company is not subjected to supervision under section 113;
(f) whether these processes adequately consider the costs of any determination or designation on the regulated entity;
(g) whether entities subject to an FSOC determination under section 113 or designation under section 804 are provided a meaningful opportunity to have their determinations or designations reevaluated in a timely and appropriately transparent manner; and
(h) whether, prior to being subject to an FSOC determination under section 113 or designation under section 804, the entity should be provided with information on how to reduce perceived risk, so as to avoid being subject to such determination or designation.
As part of this review, the Secretary shall include in the required report: the Secretary's conclusions regarding the issues enumerated above; recommendations, as appropriate, on how the FSOC processes for determinations under section 113 and designations under section 804 could be improved; and recommendations for any legislative changes necessary to improve these processes.
Sec. 2. Evaluation and Review of the FSOC. The Secretary shall also evaluate and report to the President on whether the activities of the FSOC related to the determination and designation processes under section 113 and section 804, respectively, are consistent with Executive Order 13772 of February 3, 2017 (Core Principles for Regulating the United States Financial System). In the report, the Secretary should provide, if appropriate, recommendations for legislation or regulations that would ensure that the FSOC and its activities are consistent with the principles set forth in Executive Order 13772.
Sec. 3. Temporary Pause of Determinations and Designations. Pending the completion of this review and submission of the Secretary's recommendations, the Secretary shall, to the extent consistent with law, not vote for any non emergency proposed determinations under 12 CFR 1310.10(b) or any non-emergency proposed designations under 12 CFR 1320.13(c).
Sec. 4. General Provisions. (a) Nothing in this memorandum shall be construed to impair or otherwise affect:
(i) the authority granted by law to an executive department or agency, or the head thereof; or
(ii) the functions of the Director of the Office of Management and Budget relating to budgetary, administrative, or legislative proposals.
(b) This memorandum shall be implemented consistent with applicable law and subject to the availability of appropriations.
(c) This memorandum is not intended to, and does not, create any right or benefit, substantive or procedural, enforceable at law or in equity by any party against the United States, its departments, agencies, or entities, its officers, employees, or agents, or any other person.
Source: White House
In Ireland’s view, the latest regulatory rollback effort echoes historical cycles.
After the savings and loan crisis of the 1980s and 1990s, and the failure of nearly one-third of the nation’s savings and loan associations, a number of new regulations were promulgated. “Then you started to see rollback and regulatory burden relief as the theme up until the financial crisis,” Ireland says. “That’s a window of about 15 years until we started to see things go in the other direction. That same process is going on here.”
Thus far, banks haven’t shown much eagerness for the choices offered in Hensarling’s proposed legislation, says Nicole Gelinas, a senior fellow at the Manhattan Institute for Policy Research, a think tank that describes itself as “the leading voice of free-market ideas.”
As she summarizes it, Hensarling’s plan is for banks to maintain more of their assets in capital. Banks that raise billions in extra cash would be exempt from much of Dodd-Frank, because the investors putting up this capital, not taxpayers, would bear the risk of failure.
“Big banks are unlikely to support the freedom that this new bill offers, because Dodd-Frank is far more complex, and they prefer complexity, not simplicity,” Gelinas says. “Complexity makes it harder for the government to let them fail, as the government is afraid of the consequences.”
“I haven’t seen any major bank come out in favor of it,” she adds, noting that even Hensarling has conceded that the Dodd-Frank system “confers a competitive advantage on those large financial institutions that have the resources to navigate its mind-numbing complexity.”
It would be interesting to see whether any large financial firm would choose the Financial CHOICE Act’s off-ramp “and actually volunteer to keep higher capital in return for getting out of the more macro-prudential regulations,” Gelinas says.
Gelinas agrees, however, that the Dodd-Frank Act has numerous problems that await fixes. Among them is the Orderly Liquidation Authority. “If I was in Congress, I think I would be worried that it gives the executive branch of the government the authority to take over a failing financial firm, guarantee its debt, and essentially have the FDIC run it for three to five years,” she says.
That the Financial CHOICE Act, especially in its second incarnation, isn’t quite the “scorched earth” approach some expected, is good news, says Gregory Keating chairman of law firm Choate Hall & Stewart’s Whistleblower Defense Group.
“Clear indications are that they are not going to take a hatchet to Dodd-Frank, but more of a scalpel,” he says. “In particular, not going to do away with a program that has been, by any measure, a successful and robust enforcement initiative at the SEC.”
That program is the SEC’s Office of the Whistleblower, which began the practice of paying bounties to tipsters who come forward.
“In the past year, the program has really gained momentum, more than doubling the entire amount of rewards that had been given to date,” Keating says. “The Office has collected hundreds of millions of dollars for the government in settlements.”
Nevertheless, one controversial aspect of the whistleblower program—its willingness to reward culpable individuals—is addressed in Hensarling’s legislation.
“There was a fairly significant amount of eyebrow-raising around the SEC’s decision to, in [its] words, ‘use a rat to catch a rat.’ It was their decision to give at least one bounty award to someone who was culpable in part of the wrongdoing,” Keating says. “As a matter of public policy, we go too far when we start incentivizing or rewarding those who were at the epicenter of wrongdoing. It is taking things a little too far.”
“Just as we should be holding companies to a really high standard to encourage and foster transparency, if anyone is asked to do something that is wrong they have a duty to step up and say that something isn’t right,” he adds. “The goal should be to encourage reporting at the earliest juncture. If someone is asked to do something they think is wrong, rather than just sticking with it for a period of time, and deciding to report when the ice gets too thin beneath them, they should be reporting early.”
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