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Library of Congress Cataloging-in-Publication Data:

Anand, Sanjay, 1969- author.

Essentials of the Dodd-Frank Act/Sanjay Anand.

p. cm. —(Essentials Series)

Includes index.

ISBN 978-0-470-95233-7 (pbk.): ISBN 978-1-118-02831-5 (ebk); ISBN 978-1-118-02832-2 (ebk); ISBN 978-1-118-02833-9 (ebk)

1. United States. Dodd-FrankWall Street Reform and Consumer Protection

Act. 2. Financial services industry—Law and legislation—United States. 3. Financial institutions—Law and legislation—United States. I. Title.

KF969.58201A2 2011

346.73'082—dc22

2010047242

To my son

Foreword

Great business leaders share many common positive attributes, such as intellectual curiosity and a propensity to act. In periods of significant business transformation, consummate business leaders step out even further to train and explain new business and regulatory developments to the masses.

I met Sanjay Anand at the beginning of last decade's massive regulatory overhaul, triggered by the passage of the Sarbanes-Oxley Act of 2002 (SOX). This swift legislative reaction to major corporate and accounting scandals, at Enron and other companies, caused those at publicly held companies to scramble in an attempt to grasp the compliance requirements for their organizations. Sanjay stepped up with his book, Essentials of Sarbanes-Oxley (John Wiley & Sons, 2007), which provided actionable information for those responsible for implementing SOX. I reviewed and commented on his book, and witnessed his commitment to professional development with his subsequent books and the many courses sponsored by his SOX Institute.

In the aftermath of the 2008 credit crisis and related economic downturn, once again Sanjay Anand has stepped forward to lead and explain the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) in this book.

It is crucial that everyone in business and proportionally every “consumer” understand this new and far-reaching law of the land. The Act is extensive, but even more significant are the expected regulations that will follow. Unlike earthquakes, where aftershocks diminish as time passes, the flow of regulations from the Dodd-Frank Act is anticipated to be considerable and ever expanding.

Dodd-Frank addresses too-big-to-fail bailouts and includes recommendations for risk committees at certain financial institutions. It gives the Federal Deposit Insurance Corporation (FDIC) powers to “disaffirm or repudiate any contract or lease to which the covered financial institution is a party” and recover or clawback compensation in certain circumstances. The Act expands bounties for whistleblowers and gives shareholders some “say on pay.” These are revolutionary changes of epic proportions!

For the consumer, the Dodd-Frank Act establishes a new independent watchdog agency within the Federal Reserve to make sure consumers receive clear and accurate information regarding financial products' terms and costs. It creates a consumer hotline, a new office of financial literacy, and generally expands accountability for consumer protection.

As a business executive and board member whose business foundation is as a CPA, I clearly see how important it is to update laws in order to meet modern-day business conditions and velocities. It is incumbent on all business owners and managers, and indeed all consumers, to understand the Dodd-Frank Act. More important, as a business manager and director, I call on readers to get involved in helping to shape the regulations that are certain to follow from this new law. Too much regulation—or the wrong kind of regulation—can be a drag on businesses and the economy.

Dodd-Frank is also significant in that it implements the first amendments to SOX. Who better to provide insights on Dodd-Frank than Sanjay Anand, who was among the first responders of consummate business leaders to explain SOX? You have chosen wisely, and I know you will greatly benefit from reading this book.

Michael P. Cangemi, CPA

Michael P. Cangemi, CPA, an author and business advisor, is the former president, chief executive officer, and director of Etienne Aigner Group, Inc., a leading designer of women's accessories (1991–2004), and president, chief executive officer, and director of Financial Executives International, the professional association for senior-level corporate financial executives (2007–8). He currently serves as president of Cangemi Company LLC. Mr. Cangemi recently completed a two-year term on the International Accounting Standards Board Standards Advisory Council and a year as the FEI representative on the board of COSO. For more information see www.canco.us.

Preface

On July 21, 2010, President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act; this Act is also often referred to as DFA, SOX II, the Sequel, Financial SOX, F-SOX, and other variants of these), arguably the most significant financial reform legislation enacted since the Securities Act of 1933 and the Securities Exchange Act of 1934. Just as those Depression-era pieces of legislation were crafted in response to the Great Crash of 1929, the Dodd-Frank Act grew out of what is termed the Great Recession of 2008.

At 848 pages, the final length of the Dodd-Frank Act (H.R. 4173) is considerably shorter than the 2,000-plus pages hyped by the media, yet its length and complexity far surpass the 66-page Sarbanes-Oxley Act of 2002 and the 37-page Glass-Steagall Act of 1933. Many have argued that the incremental repeal of various provisions of Glass-Steagall, such as removing the wall between investment and depository banks, sowed the seeds of the 2008 crisis—a series of events that brought our globally interwoven financial system to the brink of collapse.

Just as Sarbanes-Oxley was created to increase the transparency of and accountability within publicly traded companies, the intention of the Dodd-Frank Act was to unravel the tangled web of financial service company valuations—valuations that were all too often obscured by complex and opaque financial instruments. The introduction of H.R. 4173 on December 2, 2009, was a reaction to having witnessed banks, ratings agencies, insurance companies, accounting firms, and hedge funds serve up a toxic stew of tainted assets and liabilities that reeked of systemic non-disclosure.

As with Sarbanes-Oxley, critics have charged that the Dodd-Frank Act was hastily assembled and rammed through Congress as a short-term fix, absent consideration of its long-term consequences. Although at press time, regulators are still in the process of sorting through its requirements, creating new agencies, and seeking public comment on various regulatory provisions, it is clear that the Dodd-Frank Act will represent a sea change in the way financial services companies—from debt collection agencies to too-big-to-fail banks—conduct their governance, risk management, and compliance activities. As such, the Dodd-Frank Act of 2010 must be understood, accommodated, and mastered in order to integrate regulatory requirements with business objectives.

To stay up-to-date with the Dodd-Frank Act as it evolves from here, visit www.TheDoddFrankAct.com.

Acknowledgments

First and foremost, I would like to thank the publisher, John Wiley & Sons, for reaching out to me to write this book on a current and critical topic, a piece of legislation that is likely to reshape the financial system of not just the United States but the rest of the world as well.

Due to the tight deadline given by the publisher, I would also like to thank my wife and my son for the sacrifices they had to make due to my hectic schedule and long nights before the computer researching, writing, and editing the manuscript.

I am also grateful to my colleagues Arun Kumar and Leema Adam for their assistance in the research and writing, without which this book would not be possible, and to Sally Smith for her perspectives and edits.

I am grateful to Financial Executives International (FEI)'s past chief executive and president, Michael P. Cangemi, CPA, for his endorsement of this book through a foreword.

Finally, I thank you, the readers, who have placed your trust in this book to provide you with the information you need as you embark on your journey toward compliance with the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Chapter 1

Introduction to the Dodd-Frank Act

The Dodd-Frank Act represents a new regulatory landscape for the financial services industry. As with any newly enacted legislation, it is imperative that organizations quickly get up to speed regarding both the broad strokes and the nuances of the law. When you stay ahead of the curve, you can anticipate your organization's need for new compliance initiatives, adjust your risk management framework to ensure that you do not run afoul of the law, and prepare your corporate governance structure and corporate culture to align with both the letter and the spirit of the law.

This book will provide you with the roadmap for this new landscape. By presenting both the big picture and the details of the Dodd-Frank Act, it better prepares you to lead your organization through a path of compliance and risk mitigation.

We begin with the genesis of the Dodd-Frank Act, examining the events that led up to its introduction, the key players involved, and a review of the legislation's timeline. From there, we take each of the Act's 16 titles and probe their meanings and implications:

• Title I of the Act addresses systemic risk of the economic system and creates two new governmental agencies: the Financial Stability Oversight Council and the Office of Financial Research. The goal of the Financial Stability Oversight Council is to identify systemic risks, promote market discipline, and respond to emerging threats. The purpose of the Office of Financial Research is to provide support to the Council through administrative, technical, and analytical means.
• Title II addresses the orderly liquidation of insolvent financial companies, some of which were already covered by the Federal Deposit Insurance Corporation (FDIC) or Securities Investor Protection Corporation (SIPC), and others—such as insurance companies—and provides for the creation of the Orderly Liquidation Fund, to be funded by certain financial companies.
• Title III abolishes the Office of Thrift Supervision, dispersing its powers among the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency. It also permanently increases the maximum amount of deposits insured by the FDIC and includes provisions for ensuring ethnic and gender diversity within financial regulatory agencies.
• Title IV adds reporting requirements for investment advisors and seeks to increase transparency. It also mandates three studies, two from the Government Accountability Office (GAO) (on defining “accredited investor” and self-regulation for private funds) and one from the Securities and Exchange Commission (SEC) (on short selling and related reporting).
• Title V creates the Federal Insurance Office within the U.S. Treasury to monitor the insurance industry, administer the Terrorism Insurance Program, and identify regulatory gaps that could lead to a financial crisis. It also includes a smattering of consumer protections as well as a mechanism to allocate premium taxes to individual states.
• Title VI addresses the Volcker Rule, which creates a “church and state” separation between banking and other types of financial services, such as hedge funds and private equity funds. It also calls for greater disclosure of proprietary trading and increased capital requirements.
• Title VII regulates over-the-counter swaps and repeals the regulation exemption that existed under the Gramm-Leach-Bliley Act. In addition, the title directs the Commodity Futures Trading Commission, the SEC, and the Federal Reserve to define security swap terms and mandates the creation of a group to oversee the carbon market, spot markets, and derivative markets.
• Title VIII grants the Federal Reserve more authority with regard to systemic risk by requiring it to create uniform standards for risk management for too-big-to-fail financial institutions and to strengthen the liquidity of market utilities.
• Title IX includes a number of investor protections and mandates a variety of studies. It creates the Office of the Investor Advocate, mandates the SEC to develop point-of-sale disclosure rules for investors, and provides for a whistleblower reward program. In addition, it gives the SEC broad power to regulate shareholder proxy materials and withhold information gathered by oversight activities. Further, it regulates asset-backed securities, requires publicly held companies to garner shareholder approval for and disclose executive compensation, and mandates disclosure of incentive-based compensation.
• Title X creates an independent Bureau of Consumer Protection under the auspices of the Federal Reserve and is tasked with five broad objectives: research, community affairs, complaint tracking, fair lending, and financial literacy.
• Title XI amends the Federal Reserve Act, giving the president authority to appoint, subject to Senate confirmation, the New York Federal Reserve president, and creating the position of vice chairman for supervision on the Board of Governors. It also includes provisions for the GAO to audit the Federal Reserve and requirements for the Federal Reserve to create standards (such as risk management and capital requirements) for institutions under their supervision.
• Title XII authorizes incentives that can be used by a variety of organizations to encourage those who do not utilize mainstream financial services to do so. It creates programs to conduct activities such as microloans, financial education, and getting low- and moderate-income people to open accounts in FDIC-insured banks.
• Title XIII reduces the funds available to the Troubled Asset Relief Program and amends the Housing and Economic Recovery Act of 2008, Emergency Economic Stabilization Act of 2008, and the American Recovery and Reinvestment Act of 2009.
• Title XIV contains a number of consumer protections related to mortgages and lending. It regulates mortgage originators, establishes a semblance of underwriting standards for residential loans, defines “high-cost mortgages,” establishes an Office of Housing Counseling within the Department of Housing and Urban Development, amends the Real Estate Settlement Procedures Act, defines property appraisal requirements, and tasks the Department of Housing and Urban Development with designing a mortgage resolution and modification program.
• Title XV includes a number of miscellaneous provisions relating to everything from mine safety and the International Monetary Fund to natural resource licensing and the effectiveness of Inspectors General.
• Title XVI redefines marked to market trades in Section 1256 contracts to exclude derivatives and futures contracts or options other than dealer securities future contracts.

After delving into each title of the Dodd-Frank Act, we move into the kind of actionable information that you need in order to move forward. We cover the effective dates and rule promulgation deadlines that you need to have handy as well as outlining the institutions impacted by the Act. From there, we review related legislation and rulemaking that could impact your industry and your organization, such as the Truth in Lending Act, the Fair Credit Reporting Act, and the Investment Advisers Act.

Then, after a summary of the roles of new and existing governmental agencies as defined by the Act, we analyze the global impact and implications of the Act for the banking and investment industries.

Next, we offer valuable advice for professionals impacted by the Dodd-Frank Act, including those involved with executive management, municipal securities markets, and broker-dealers.

Finally, we examine the Dodd-Frank Act's relationship to the Sarbanes-Oxley Act of 2002 (SOX) as well as its relationship to the Basel Accords. After all, newly minted legislation often leaves imprints on the statutes that preceded it and sometimes has unintended consequences. If your organization is required to be SOX compliant, it is crucial to understand how the Dodd-Frank Act will impact your compliance initiatives.

Although this book is written primarily for senior-level professionals, executives, and board members in the financial services and legal professions, it will also be useful to those in other disciplines, such as accounting, audit, information technology, and ethics. Like SOX, the Dodd-Frank Act will affect those at every organizational level, from the chief executive to middle management and beyond. This book seeks to impart information to anyone who may be impacted by the Act, both to prepare for the regulations that will inevitably follow and to create a roadmap for implementing specific titles and sections of the Act within organizations.