An amended version of the US Dodd-Frank Act 2010 was signed into law last week after a number of its provisions were re-drawn or re-interpreted.
Investors might want to engage with companies falling outside the scope of the amended legislation to gain confidence that these companies have adequate corporate governance systems in place to ensure their financial stability once they are no longer subject to the previous Dodd-Frank financial control mechanisms.
The US President has signed the Economic Growth, Regulatory Relief, and Consumer Protection Act into law after protracted discussions about whether and how to maintain the main Dodd-Frank Act requirements enacted in 2010 to prevent another global financial crisis. Amendments include increasing the assets threshold for more stringent regulatory requirements at banks from $50 billion to $250 billion. This increase means that the main Dodd-Frank provisions will now apply only to the thirteen largest US banks.
Three elements of the Dodd-Frank Act have been scaled back: the financial stability regulation, the Volcker Rule and bank capital requirements and mortgage lending rules. The reduced obligations mean that around 25 banks currently subjected to stress tests will no longer face such requirements and will no longer be subject to capital and liquidity requirements and living wills. The amendments also reduce risk management provisions and capital requirements for smaller banks, and remove requirements for some banks to produce bankruptcy plans. The Financial Stability Oversight Council will lose its power to designate systematically important financial institutions, and the proposed legislation withdraws the Volcker Rule for banks with less than $10 billion in assets. However, the Federal Reserve will maintain the right to supervise banks with assets between $100 billion and $250 billion. The aim of these changes has been to protect smaller banks – including community banks – from onerous requirements they feel should only apply to their larger counterparts.
However, some critics are concerned that the amendments ignore the lessons of the financial crisis. Gillian Tett of the Financial Times has pointed out that the timing of the amendments is questionable given the expanding US economy and a deterioration in credit quality, among other concerns. Additionally, this proposal comes at a time when the European Systemic Risk Board is recommending that a stronger liquidity stress test be adopted by the EU.
It might also be worth considering that there could be informal ‘creep’ in this area. For example, the abovementioned thresholds might continue to be raised, lowered, or supplemented by permissive policy with no accountability for the changes. Furthermore, retraction of other Dodd-Frank provisions passed after the financial crisis might mean that the new thresholds and reduction in reporting requirements would not operate in a legal or policy context that could help to pre-empt another such crisis.
As a due diligence measure, investors could contact the 25 or so investee companies no longer meeting original thresholds to ensure that they still have systems in place to disclose risks to investors. Otherwise, there is a fear that we could see a repeat of the last financial crisis, the effects of which are still being felt by many bank stakeholders.
In a related development, the US Supreme Court recently found that the Dodd-Frank Act’s whistleblower protection is narrower than an interpretation put forth by the Ninth Circuit Court of Appeals. According to the Supreme Court, employees wanting to sue publicly-traded employers for retaliation under Dodd-Frank must report possible securities violations to the SEC before reporting them internally to employers. This interpretation could mean that it will take companies longer to identify and respond to such violations, which could lead to legal and reputational risk. Such a development could impede timely identification of problems stemming from the abovementioned financial oversight changes.
Investors could engage with investee companies to check that they have appropriate grievance mechanisms in place to catch potential and actual violations early.
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