Dodd-Frank Act Still a Work in Progress

This is a crucial year for the Dodd-Frank Act. More than 70 percent of its required rulemaking is either proposed or finalized, on track to take effect in the weeks and months ahead. For the first time, enough pieces of the regulatory reform puzzle are snapped into place to make an early assessment of if it is living up to its promises, or at least if it has the potential to.

Will it succeed in its goal to ensure stable financial markets by closing loopholes and creating new oversight? Is it flexible enough to keep markets safe for years to come and vaccinate an easily wounded economy protected from greed and excessive risk taking?

What will its ultimate legacy be? That depends both on how well it works in the days ahead and whether critics who want to kill or modify what they still can will help improve the law or sabotage it.

Dodd-Frank's architects ambitiously positioned the package as another face on the Mount Rushmore of financial reforms, alongside the New Deal, Securities Act of 1933, and Sarbanes-Oxley Act. Meanwhile, critics saw little but red tape and job killing. Thousands of industry lobbyists hunkered down in their Washington D.C. beachheads, intent on casting away specific rules or, at least, shaping them into something less onerous.

In Congress, getting the necessary votes was no easy task. “It was a very stressful period,” says former Congressman Barney Frank, a namesake of the Act along with former Senator Christopher Dodd. “Part of the problem was that the Republicans were clearly not going to give us any votes. Every night, the last thing I would think about before going to sleep was the number 36. I spent a year-and-a-half trying to get 36 votes on everything.”

After the Dodd-Frank Act was enacted in the summer of 2010, it was immediately greeted by Congressional plans to undo it. While blanket promises of full repeal never gained much traction—although a Romney Administration might have changed that—attacks still persist from all corners.

With so much of the required rulemaking complete, efforts to kill the Act are now next to impossible, say legal experts. There is still plenty of room, however, to stall individual rules and amend existing ones. Efforts to do so are not just a Republican mission—some have bi-partisan backing.

Congressman Jim Himes, who represents the financial services-laden state of Connecticut, is in a unique and controversial, position. As a Democrat who voted, with no regrets, in favor of the Dodd-Frank Act, he also leads the charge to amend key portions. That has put him in the unenviable position of drawing fire from both parties.

“It's been excruciating,” he says. “Unfortunately, there is still so much residual rage at the financial services sector, and our politics are still so polarized, that it is all but impossible to have the conversations you want to have in the face of a new regulatory regime. What are we learning? What's going wrong? What can we adjust? Instead, this is essentially a morality play where you are pegged as either in the camp of believing Dodd-Frank is being systematically diluted and was not strong enough in the first place, or you are into the camp that wants it repealed.”

As it was in the beginning, so it is now, with lobbyists adding to the legislative logjam. “The industry has pushed hard in some areas that I suspect are unwise and more related to their interests than to a well functioning industry,” Himes says. “On the flip side, there are certainly parts of Dodd-Frank that are very awkward.”

What's next on Washington's fix it-list? Front-row, center is the Volcker rule, a prohibition on proprietary trading by federally insured banks added onto the Dodd-Frank game late in the process.

“The Volcker rule is very important and very problematic,” Himes says. “It is very difficult to dispute that banks should not be placing proprietary bets, but the actual rules to implement that simple proposition are very challenging. I don't think the Volcker rule is a bad idea. I think it is essential. But it is proving very difficult to apply it to the actual operations of the market.”

Success in Legal Challenges

“This is essentially a morality play where you are pegged as either in the camp of believing Dodd-Frank is being systematically diluted and was not strong enough in the first place, or you are into the camp that wants it repealed.”

—Jim Himes,

Congressman,

Democratic Party

Where legislative redress has failed, trade associations and politically motivated think tanks—including the American Bankers Association, U.S. Chamber of Commerce, National Association of Manufacturers, American Petroleum institute, and Competitive Enterprise Institute—have, and will, turn to the courts.

Legal challenges have been met with some success. A 2011 court decision threw out Securities and Exchange Commission rules associated with Dodd-Frank's proxy access rule, which would have required companies to give investors a right to place director nominees on proxy materials, making contested elections more likely. The conflict minerals rule, also pushed along to the SEC, is currently in legal limbo, with an appeals court decision expected in the coming weeks that could hinge on whether forcing companies to disclose their use of minerals mined in the war-torn Congo on their own Websites violates their First Amendment protections. A requirement for oil, gas, and mining companies to disclose any payments made to governments for extraction rights was already rejected by courts on that same logic and is being redrafted by the SEC.

In one industry victory that never made it to the courtroom, the American Bankers Association dropped a planned lawsuit once regulators relented and decided to provide a Volcker rule exemption to certain debt securities commonly owned by community banks.

“Legal challenges have certainly knocked out provisions of Dodd-Frank,” says Tom Quaadman, vice president of the U.S. Chamber's Center for Capital Markets Competitiveness. Many of those challenges have zeroed in on what critics say is often an incomplete cost-benefit analyses of rulemaking. This sent a signal to regulators that “shoddy cost benefit analyses are not going to wash,” he says.

                   ABOUT THIS SERIES

Compliance Week's exclusive four-part series on the Dodd-Frank Act will take a look at the state of rulemaking to carry out the 2010 landmark reform law. We'll explore how well some of the law's components are working and if it has had the intended effect of improving corporate governance and creating stability in the banking sector, along with what it is costing companies to comply and what's still to be done to finish rulemaking on the law.

Part 1: The Dodd-Frank Act: Where Are We Now, Feb. 4Part 2: How the Dodd-Frank Act Is Changing Corporate Governance, Feb. 11Part 3: The Costs of the Dodd-Frank Act, Feb. 19Part 4: Dodd-Frank Act Still a Work in Progress, Feb. 25

“The challenges have been successful to the extent that they are a warning to regulators that they can't cut as many corners as they might otherwise be inclined to,” says Hester Peirce, a senior research fellow at the conservative Mercatus Center at George Mason University. “Even if you don't see direct success with a particular lawsuit, there are good incentives provided just by the fact that they are out there.”

Litigation has slowed the pace of Dodd-Frank rulemaking far more than similar threats affected other major reform initiatives, says David Zaring of the University of Pennsylvania's Wharton School. “With the Sarbanes-Oxley Act, agencies also had a lot of rulemaking to do, but most of those rules survived judicial review and were implemented much more quickly,” he says. “It was a different world than the one we are seeing with Dodd-Frank and the prospective litigation that is coming.”

The Legacy Question

While defending the statute, and pleased by its success thus far, Frank does have some lingering concerns and regrets—although very few of them. One is that, despite his intent, risk retention requirements may not be imposed upon all mortgages. Another is that auto dealers were not included under the purview of the CFPB. At least the banks that finance auto loans are, he says.

Frank also regrets that the Act failed to merge the SEC and CFTC.  “If you were starting from scratch, you wouldn't have a separate SEC and CFTC. It doesn't make sense,” he says. “It is all so deeply rooted politically. The farmers would have just been in a revolt if they were lumped in with the city slickers on Wall Street. The cultural divide between the agricultural and financial communities made it impossible. I hope they do it separately some day, but it wasn't possible in the context of an already controversial bill.”

Costs to Companies Dominate Legal Challenges

Below CW's Joe Mont explains some of the legal challenges to the Dodd-Frank Act.

In July, Judge John Bates of the Federal District Court of the District of Columbia nullified Securities and Exchange Commission rulemaking that, in accordance with the Dodd-Frank Act, would require oil, gas, and mining companies to disclose payments made to governments for extraction rights.

Typical of legal challenges to Dodd-Frank Rulemaking, the lawsuit, filed by the U.S. Chamber of Commerce and American Petroleum Institute, took a multi-pronged approach, and one that focused on the lack of what they considered an adequate cost-benefit analysis.

Among their arguments:

“While the Commission did not quantify how many ‘billions of dollars' more its rule might cost U.S. businesses, it acknowledged that American companies may be forced to ‘sell their assets in the host countries at fire sale prices,' or else keep existing assets idle and ‘not use them in other projects.'”

“In calculating the competitive costs associated with the potential for lost business in countries that prohibit the required disclosures, the Commission did not even bother to determine how many countries had laws on the books prohibiting disclosure. Rather, it merely stated that commenters' concerns regarding lost business ‘appear warranted,' and that host country laws “could add billions of dollars of costs to affected issuers.”

“SEC Commissioner Gallagher dissented from adoption of the rule, criticizing the Commission for failing to adequately tailor the Rule to avoid significant adverse effects on competition and capital formation. ‘We are not at liberty,' he explained, ‘to ignore selectively the longstanding congressional mandate to consider the impact our rulemaking is likely to have on competition.'”

—Joe Mont

Source: American Petroleum Case.

Frank doesn't hesitate, however, when asked what the legacy of the legislation will be. He is confident it will prevent economic calamities for the foreseeable future. “We are much less prone to the irresponsible risk taking we saw before,” he says. “On the other side, this has not in any way interfered with the functioning of the economy. Some banks may not be making as much profit, but the banks serve the economy, not the other way around. The stock market has done extremely well since the bill passed, so obviously it didn't have any negative effect there.”

Several studies bear out his assertion that banks are healthier, with greater liquidity and better quality assets on hand to buffer shocks than before the crisis. Dodd-Frank pushed Big Banks to rethink their risk strategies. When they don't, they can face multibillion-dollar government fines.

The key to the Act's success, Frank says, is that lawmakers anticipated that new problems would arise, so they fully empowered regulators to deal with them.  The centerpiece of that flexible, forward-thinking approach was the creation of the Financial Stability Oversight Council, comprised of representatives of all the financial regulatory agencies and handed a broad mandate.

“We learned from the financial crisis what happened when agencies didn't work together,” Frank says. “The bill institutionalized the need for them to work together. If something falls between the cracks of the current jurisdictions, they can now deal with it.”

Just as there is talk of a JOBS Act 2.0, a Dodd-Frank sequel may also be on the horizon. “There should be one eventually” Himes says.

First, however, the heated political climate must cool. “The White House has made the argument that while the rules are being written it is premature to start thinking about amendments,” he says. “There is merit to that argument, but it is an academic one. It is nearly impossible to do a package of fixes because it is very hard for people of opposing views to find common ground.”