Financial Reform Watch : Financial Services News & Information : Blank Rome Government Relations Lobbying Firm : Government Relations, Corporate Governance : Financial Reform Watch Law Blog

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act provides the most sweeping overhaul of the regulation of the U.S. financial services industry and financial markets since the aftermath of the Great Depression. The Act represents Congress’ attempt to address the myriad of issues arising out of the financial crisis and marks the conclusion of over a year’s effort to craft a legislative solution designed to avoid another financial crisis. The legislation requires an overhaul of the regulatory landscape and establishes a new regulatory scheme to govern certain public companies, banks, insurance companies, hedge funds, as well as other companies in the financial services industry.

The new legislation is designed to address systemic risk in the U. S. financial system and remediate the “too big to fail” issues which required government bailouts of several large financial services companies during the financial crisis. The legislation also implements new corporate governance and disclosure requirements applicable to public companies, increases the regulatory requirements applicable to banks, insurance companies and hedge funds and subjects certain large financial services companies to regulation by the Federal Reserve Board (the “FRB”).

The new legislation adds several new corporate governance and disclosure requirements applicable to companies listed on U.S. stock exchanges and in some instances, other publicly-traded companies, including:

• a requirement for having a non-binding shareholder vote on compensation of specified executive officers and in certain instances golden parachute provisions;
• a requirement for more stringent rules and disclosure applicable to compensation committees;
• a requirements for additional disclosure requirements related to executive compensation;
• the elimination of discretionary voting by brokers in connection with the election of directors, executive compensation issues or other significant matters;
• authorization for the SEC to adopt rules related to proxy access; and
• a requirement to adopt clawback policies with respect to employment arrangements of executives of companies seeking to list on a U.S. stock exchange.

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While the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has been widely identified as having a broad and sweeping impact on the financial markets as a whole, it will most certainly also have a dramatic impact on the structuring and implementation of asset-backed securities. More particularly, the parties involved in structuring and executing collateralized debt obligations (“CDOs”) and collateralized loan obligations (“CLOs”) may be significantly impacted by the risk retention (or “skin-in-the-game”) requirements under Section 941 of the Dodd-Frank Act (the “Risk Retention Requirements”). Important elements establishing the mechanics and implementation of the Risk Retention Requirements will remain unclear, however, until regulators promulgate further required rules.

As set forth in the Dodd-Frank Act, the Risk Retention Requirements direct that distinct regulations be issued by the Federal banking agencies and the Securities and Exchange Commission (the “Commission”) for each category of ABS, including residential mortgages, commercial mortgages, auto loans, and any other applicable categories of Asset-Backed Securities. The risk retention rules must be prescribed within 270 days after enactment (i.e., by April 15, 2011) and must go into effect within two years after the date final rules are published for all asset classes other than residential mortgages (i.e., not later than April 15, 2013).

The Dodd-Frank Act defines “Asset-Backed Securities” as “a fixed-income or other security collateralized by any type of self-liquidating financial asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset, including (i) a collateralized mortgage obligation; (ii) a collateralized debt obligation; (iii) a collateralized bond obligation; (iv) a collateralized debt obligation of asset-backed securities; (v) a collateralized debt obligation of collateralized debt obligations; and (vi) a security that the Commission, by rule, determines to be an asset-backed security for purposes of this section.” While the statutory language makes it clear that the Risk Retention Requirements apply to CDOs, it does not expressly include CLOs. Presumably, CLOs will be included in the regulations either by application of a broad definition of “collateralized debt obligations” or by express inclusion by the Commission as an asset-backed security subject to the Risk Retention Requirements.

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The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which was signed into law on July 21, 2010, has an immediate effect on many private securities offerings. Specifically, the Act revises the net worth test for determining whether an individual investor is an “accredited investor” for purposes of Regulation D and Section 4(6) of the Securities Act of 1933 (the “Securities Act”).

Regulation D is the exemption under the federal securities laws that many issuers, including venture capital firms and real estate and private equity funds, rely upon to raise capital from investors in non-public offerings. This exemption is also often relied upon in many non-public M&A transactions in which the acquiror uses its stock as acquisition consideration. Section 4(6) is a statutory exemption available for private placements solely to accredited investors.

Section 413 of the Act requires the SEC to make a change to the net worth test contained in the definition of “accredited investor” that is applicable to all offerings exempt under Regulation D (especially Rule 506) and Section 4(6) of the Securities Act. Under the net worth test, an investor must have (either individually or together with the investor’s spouse) more than $1 million of net worth at the time of the purchase. As amended by Section 413 of the Act, the value of the investor’s primary residence is now excluded from the calculation of net worth. The SEC has indicated in a Compliance & Disclosure Interpretation (“C&DI”) dated July 23, 2010 that the amount of any indebtedness secured by the principal residence should be netted from the value of the residence (except where the amount of the debt exceeds the fair market value of the residence and the lender has recourse to the investor personally for such excess, in which case such excess liability is deducted from net worth).

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Today the Senate Agriculture Committee, led by Chairman Blanche Lincoln (D-AR), completed its work on the over-the-counter derivatives section of financial regulatory reform. By a vote of 13 to 8, the committee adopted the Wall Street Transparency and Accountability Act. Sen. Charles Grassley (R-IA) was the only Republican to join the committee Democrats in voting for the bill.

The Senate is set to vote to end the filibuster on the Senate Banking Committee bill next Monday evening, which would allow Banking Chairman Chris Dodd (D-CT) to bring the legislation to the floor next Tuesday, April 27. The Monday night vote is dependent on getting at least one Republican to break ranks and vote for cloture, which would end the delay. No one knows which Republican will cave, but some likely candidates are the moderate Senators from the Northeast: Olympia Snowe (R-ME), Susan Collins (R-ME), or Scott Brown (R-MA).

We expect Sen. Dodd to incorporate Lincoln’s Wall Street Transparency and Accountability Act into the financial reform package he brings to the floor. Following are a few shorthand highlights of the Lincoln bill, but click here for the Senate Agriculture Committee’s more extensive summary and the most up to date bill language.

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After 15 months of unprecedented intervention in the secondary mortgage market, the Federal Reserve—currently the proud owner of nearly 25 percent of mortgage debts—is calling it quits. The Fed's $1.25 trillion emergency program to stabilize the U.S. housing market through the purchase of mortgage-backed securities (MBS) officially expires today.

First announced in November 2008, the Fed initiative to purchase MBS issued by government sponsored enterprises (GSEs )—including Fannie Mae, Freddie Mac, and Ginnie Mae—has largely been viewed as a catalyst in spurring the nascent recoveries in both the housing and stock markets, helping to lower home mortgage rates and free up capital for private investors. In particular, market analysts credit the Fed purchasing program with paving the way for a record $375.4 billion of investments into bond mutual funds in 2009, as lower returns on mortgage securities led investors to corporate bonds, equities, and other riskier assets.

At a time when the U.S. economy remains fragile, the Fed’s departure from the housing sector may help determine just how fragile economic conditions really are. For months, market observers have raised concerns that a Fed exit could cause significant spikes in mortgage rates, leading to higher foreclosures and a slump in investor confidence. In fact, Fannie Mae's and Freddie Mac’s February announcement that they will repurchase $200 billion in delinquent mortgage loans, was a tacit acknowledgement that government backstops cannot be removed swiftly.

However, a number of analysts are also predicting that the effects of the Fed pullout will be rather minimal, as the current shortage of AAA-rated debt has made private fund managers increasingly eager to begin reinvesting in MBS, especially when such securities are backed by propped-up GSEs like Fannie Mae and Freddie Mac. In addition, these analysts also project that U.S. banks—which have steadily increased capital levels and are now flush with extra cash—will step up to fill the void left by the Fed.

The role of both Fannie and Freddie in ensuring a smooth transition for the housing finance system will be something to watch closely over the next few months. The GSEs are under intensified scrutiny on Capitol Hill, as the Obama administration prepares a sweeping proposal for a GSE overhaul. Treasury Secretary Tim Geithner told Congress last week that the administration will initiate a public comment period on April 15 in order to solicit ideas for Fannie and Freddie’s restructuring.
 

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Not surprisingly, the Federal Reserve announced today that it is extending the TALF program from the December 31, 2009 deadline to March 31, 2010 for newly issued ABS and legacy CMBS and to June 30, 2010 for newly issued CMBS. While the Fed acknowledges that conditions in the financial markets have improved, it still views the markets for asset backed securities and commercial mortgage backed securities as "impaired." The Fed is also leaving the door open to further extensions should conditions warrant. Another outstanding issue is whether to expand the TALF to include other types of eligible collateral. The Fed said in its announcement that it and Treasury will reconsider the issue "if financial or economic developments indicate that providing TALF financing for investors' acquisitions of additional types of securities is warranted."

Federal Reserve Press Release, August 17, 2009

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After nearly four months of delay, the Treasury on Wednesday launched the Legacy Securities program—a key component of the administration’s Public-Private Investment Program (PPIP) aimed at relieving financial institutions of illiquid assets that continue to hamper the flow of credit markets.

Scaling back the scope of the Legacy Securities program as originally envisioned in March, the Treasury, together with the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve, offered a framework that will provide government investments of up to $30 billion so that private sector fund managers and private investors might purchase legacy commercial mortgage-backed securities (MBS) and non-agency MBS off the balance sheets of banks and other financial institutions.

Selected from a pool of over 100 applicants, below is a list of the nine private fund managers pre-qualified by Treasury to participate in the initial round of the Legacy Securities program:

• AllianceBernstein, LP and its sub-advisors Greenfield Partners, LLC and Rialto Capital Management, LLC
• Angelo, Gordon & Co., L.P. and GE Capital Real Estate
• BlackRock, Inc.
• Invesco Ltd.
• Marathon Asset Management, L.P.
• Oaktree Capital Management, L.P.
• RLJ Western Asset Management, LP.
• The TCW Group, Inc.
• Wellington Management Company, LLP

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On May 27, 2009, the Securities and Exchange Commission (the “SEC”) proposed amendments to Rule 206(4)-2 under the Investment Advisers Act of 1940 (“Advisers Act”) which governs custody arrangements for registered investment advisers (“Rule 206(4)-2”).

The proposed rule, if adopted, would require registered investment advisers that have custody of client funds or securities to undergo an annual surprise examination by an independent public accountant to verify client funds and securities. In addition, unless client accounts are maintained by an independent qualified custodian (i.e., a custodian other than the adviser or a related person), the adviser or related person must obtain a written report from an independent public accountant that includes an opinion regarding the qualified custodian’s controls relating to custody of client assets.

Finally, if adopted, the proposed rule would provide the SEC with better information about the custodial practices of registered investment advisers. The proposed rule is designed to provide additional safeguards under the Advisers Act when an adviser has custody of client funds or securities. Comments on the SEC’s proposal are due to the SEC on or before July 28, 2009.

Excerpt from the Corporate and Securities Update published by Blank Rome LLP, click here to read the full alert.

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President Obama today released the long-awaited proposal for reform of the regulatory structure overseeing the financial services industry. It is a sweeping proposal with broad implications for the entire industry. It reshuffles regulatory powers, combines some agencies, creates a new one and extends federal regulatory powers to products and firms which are currently not federally regulated or regulated at all. Congress, the industry,the media and other stakeholders are poring over the 85-page "white paper" describing the proposal. Click here to go to the document.
 

Brief Summary

1.      Avoid Future Systemic Risk/Promote Robust Supervision and Regulation – Raise capital and liquidity requirements for banks and systemically significant financial firms; establish a Financial Services Oversight Council of regulators to coordinate and prevent systemic risk; establish a new National Bank Supervisor in Treasury to oversee federally chartered banks; bring hedge funds and other private pools of capital into the regulatory framework; require public companies to hold non-binding say-on-pay shareholder votes and have independent compensation committees; review accounting standards; establish the Office of National Insurance within Treasury to enhance oversight of the sector.

2.      Reform the Structure of the Financial System – impose “robust” reporting requirements on issuers of asset-backed securities; reduce reliance on credit rating agencies; require the originator, sponsor or broker of a securitization to retain a financial interest in its performance; harmonize the regulation of futures and securities; safeguard payment and settlement systems; subject all derivatives trading to regulation; strengthen oversight of systemically important payment, clearing and settlements systems.

3.      Protect Consumers and Investors – improve the SEC’s ability to protect investors and establish a new Consumer Financial Protection Agency to identify gaps in supervision and enforcement; ensure the enforcement of consumer protection regulations; improve state coordination; and promote consistent regulation of similar products.

4.      Enable the Government to Manage Financial Crises -- establish a resolution mechanism, similar to the FDIC’s,  for non-bank financial firms and subject those whose failure could harm the financial system (Tier I Financial Holding Companies) to Fed supervision; require the Fed to get Treasury sign off when the Fed invokes its emergency lending authority for “unusual and exigent circumstances.”

5.      Improve International Supervision and Coordination – improve oversight of global financial markets; strengthen the capital framework; coordinate supervision of international firms; enhance crisis management tools.

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The Federal Reserve announced this afternoon that starting in June, commercial mortgage backed securities (CMBS) would be eligible assets for the Term Asset Backed Securities Loan Facility (TALF). The Fed is also expanding the term on some CMBS TALF loans to five years, up from three year terms for other assets. The Federal Reserve Bank of New York plans to set up a separate TALF subscription cycle for CMBS, which will occur later each month than the regular TALF cycle. The longer-term CMBS loans will also have larger haircuts.

Term Asset-Backed Securities Loan Facility (CMBS): Terms and Conditions

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Some surprises were included in today's announcement by the Federal Reserve and the Treasury on new developments with the soon-to-be $1 trillion Term Asset-Backed Securities Loan Facility (TALF). Of particular note is the statement that the two agencies will push for legislation to re-tool the program.

According to the joint release, the TALF is “designed to catalyze the securitization markets by providing financing to investors to support the purchase of certain AAA-rated asset-backed securities” and will at first be limited to newly and recently originated auto, credit card, student, and SBA-guaranteed small business loans. The TALF funds will go out monthly starting in March, and they are already anticipating a program expansion for April that will include “asset backed securities (ABS) backed by rental, commercial, and government vehicle fleet leases and ABS backed by small ticket equipment, heavy equipment, and agricultural equipment.” The Treasury and the Fed are also analyzing how to expand the program in future months to include commercial mortgage backed securities and other AAA-rated, newly issued ABS.

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The Federal Reserve announced two new programs today, committing an additional $800 billion in order to spur lending. U.S. Treasury Secretary Hank Paulson also announced that $20 billion from the Troubled Asset Relief Program (TARP) would be used to support one of the programs. The first, worth $600 billion, is aimed at helping the housing market; and the second Fed program, worth $200 billion, is directed at thawing the frozen consumer credit markets.

The Fed announced this morning that it will "initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)—Fannie Mae, Freddie Mac, and the Federal Home Loan Banks—and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae." The Fed will work with "primary dealers through a series of competitive auctions" for purchases of up to $100 billion in "GSE direct obligations" beginning next week. For purchases of up to $500 billion in MBS, the Fed will select asset-managers through a competitive process and plans to start these purchases before the end of the year. The Fed said in a release that it will provide operational details after "consultation with market participants," and added that "Purchases of both direct obligations and MBS are expected to take place over several quarters."

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Events of yesterday continued to demonstrate how major elements of the current financial crisis are interrelated. First, with the world waiting to see how a new administration in Washington will approach the financial crisis, President Bush's announcement of a November 15 summit of international leaders puts the discussion of a new regulatory regime for the financial sector squarely in the middle of the U.S. presidential transition. While both Sens. John McCain and Barack Obama praised the summit, it will present the winner of the November 4 election with an interesting quandary—how to participate in and/or react to the event. It may also force the hand of the President-Elect to name his economic team before the summit takes place. Doing so will allow the administration-in-waiting to have a more organized response to the events of the summit.

Second, the impacts of the financial crisis on the U.S. auto industry may be putting additional pressure on the $700 billion rescue package enacted on October 3. As potential car buyers continue to face a credit crunch, bipartisan leaders of the Michigan congressional delegation yesterday urged the Treasury to make a portion of the funds available to back auto loans. The request came from House Energy and Commerce Committee Chair John Dingell (D-MI) and Rep. Fred Upton (R-MI). If Treasury takes up that suggestion, funds available to supply capital to community banks or purchased troubled mortgages would be reduced.

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A short time ago, Treasury Secretary Hank Paulson announced some much-awaited details about the Department’s Capital Purchase Program (CPP). The Treasury will invest $250 billion of capital to U.S. financial institutions in the form of preferred stock. Nine of the largest banks have already agreed to participate in the CPP, which leaves $125 billion remaining. Paulson stressed that the program will not be implemented on a first-come-first-served basis, stating, "Sufficient capital has been allocated so that all qualifying banks can participate."

The Department has developed a single application form for qualified, interested banks to submit to their primary federal regulator—the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of Comptroller of the Currency, or the Office of Thrift Supervision. Once a bank’s primary regulator reviews the application, the regulator will forward the bank’s application to Treasury’s Office of Financial Stability for approval. Paulson said Treasury will "give considerable weight" to the recommendations of the federal regulators. The terms will be the same for all applicants, and regulators will use a standardized review process. Treasury will announce all transactions within 48 hours of execution; however, the Treasury will not publicly reveal any applications that are withdrawn or denied. The application deadline remains November 14, 2008.

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World stock markets responded well this morning to the emerging consensus among European and U.S. officials to focus on capitalizing banks with government funds in exchange for an ownership stake in them. Wednesday's announcement from U.K. Prime Minister Gordon Brown that he plans to inject capital directly into banks and to guarantee interbank lending accelerated momentum for similar moves by the United States and European central bankers. Meetings on Friday and over the weekend among the G7 finance ministers and at the International Monetary Fund in Washington helped to bring these key players into alignment.

Meanwhile, the Treasury Department took further steps to implement the Troubled Asset Relief Program (TARP). In a speech this morning before the Institute of International Bankers, acting assistant secretary of the Office of Financial Stability (OFS) Neel Kashkari outlined progress and the seven internal policy teams established to execute the TARP: 

1. Mortgage-backed Securities Purchase Program—will examine which assets to purchase, from whom, and how
2. Whole Loan Purchase Program—will work with bank regulators to determine which loans to purchase first, how to value them, and how to purchase them
3. Insurance Program—on Friday, Treasury solicited public comments on how to insure troubled assets; comments are due within 14 days, at which point OFS will develop the program
4. Equity Purchase Program—will establish a standardized program to buy equity in a broad array of financial institutions; program will be voluntary with attractive terms so healthy institutions will participate and also raise private capital to complement public capital
5. Homeownership Preservation—will work with the Department of Housing and Urban Development to help homeowners when the Treasury purchases mortgages and mortgage-backed securities
6. Executive Compensation Program—will define firms’ participation requirements for three scenarios: auction purchase of troubled assets, broad equity or direct purchase program, and an intervention to prevent the failure of a systemically significant firm
7. Compliance Program—will set up the Oversight Board, the on-site participation of the General Accounting Office, the selection of a special inspector general, and all the reporting mechanisms

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As implementation of the financial rescue package accelerates, Treasury Secretary Hank Paulson today outlined at a press conference steps underway to implement the Troubled Asset Relief Program (TARP). Among those steps is the appointment of Neel Kashkari, a 35-year-old aerospace engineer whose resume includes a Wharton MBA and investment banking for Goldman Sachs, to be the interim head of the new Office of Financial Stability. The process for selecting firms to manage assets and assist in administering the TARP is underway. While it is moving quickly, we anticipate there will be additional opportunities in the near future for asset management firms and other service providers to be involved.

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Between the bookends of last night's presidential debate and tomorrow's 4:15 p.m. kickoff of the Redskins-Cowboys game, official Washington is working hard to reach a compromise financial rescue plan. Staff members from both parties and both Houses of Congress met into the wee hours of the morning today on the legislation. Leaders hope to announce a plan on Sunday before the Asian markets open for their Monday sessions. Votes in the House and Senate are currently planned for Monday.

Staff members are meeting as this is written. The lead negotiators on the package are expected to meet this afternoon to review staff progress. As we noted in our final update yesterday, negotiators appear ready to graft onto the package a proposal from the House GOP to allow Treasury the option to develop an insurance program to support mortgage backed securities. Given Secretary Paulson's earlier comments that an insurance program would not be adequate to address the problems in the marketplace, it is unlikely he would use this option. However, including it in the plan provides a fig leaf to those who indicated they would try to block the plan that appeared headed for enactment before Thursday's White House meeting.

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In a day of fast-moving developments there are some signs that discussions on a financial rescue package may re-start in a constructive way. According to Sen. Harry Reid (D-NV), House Republicans have agreed to return to the negotiating table at the noon hour under the leadership of House Minority Whip Roy Blunt (R-MO). To the extent the conversation is required to reach a compromise, this is a sign of progress in getting to a deal. Blunt will be bringing with him an outline of the House GOP plan to deal with the financial crisis. The key elements of that plan are the following:

• Federal insurance of mortgage-backed securities (in addition to the insurance already provided to Fannie Mae and Freddie Mac products). Premiums paid by asset owners would support the program.
• Regulatory and tax relief for the financial industry (e.g ability to suspend dividend payments).
• A cut in the capital gains tax.
• Greater transparency in reporting of the types of assets held by financial institutions and greater SEC scrutiny of audit reports.

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This morning’s Senate Banking Committee hearing was still continuing as the Bush Administration, House Banking Committee Chairman Barney Frank (D-MA), and House leadership were making plans for an urgent briefing today at 4 p.m. to convince House members to agree to the Treasury’s Troubled Asset Relief Program (TARP). Press reports about this morning’s House Democratic and Republican conference meetings characterized members’ reactions as “resistant.” Our sources on the Hill and off are saying the meetings were worse than reported, and the mood at both was antagonistic. As of now, the House does not have anywhere near the 218 votes needed to pass the Treasury plan, even with Chairman Frank’s endorsement.

Members of the Senate Banking Committee, including Sen. Chuck Schumer (D-NY), questioned whether the TARP could be funded in installments, precluding the need for Congress to authorize $700 billion in one lump sum. However, both Federal Reserve Chairman Bernanke and Paulson rejected the suggestion, saying that bolstering consumer confidence requires Treasury to have the full $700 billion authority, even if they do not utilize the entire amount. Both Paulson and Bernanke repeated on several occasions that lawmakers must not view the $700 billion as an expenditure, but as an investment that would be recovered – though perhaps not in full – over time.

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The Treasury Department this past weekend submitted legislation to the Congress requesting authority to purchase troubled assets from financial institutions in order to promote market stability, and help protect American families and the US economy. This program is intended to fundamentally and comprehensively address the root cause of our financial system's stresses by removing distressed assets from the financial system.

The following description reflects Treasury's proposal as of Saturday afternoon.

Scale and Timing of Asset Purchases. Treasury will have authority to issue up to $700 billion of Treasury securities to finance the purchase of troubled assets. The purchases are intended to be residential and commercial mortgage-related assets, which may include mortgage-backed securities and whole loans. The Secretary will have the discretion, in consultation with the Chairman of the Federal Reserve, to purchase other assets, as deemed necessary to effectively stabilize financial markets. The timing and scale of any purchases will be at the discretion of Treasury and its agents, subject to this total cap. The price of assets purchases will be established through market mechanisms where possible, such as reverse auctions. The dollar cap will be measured by the purchase price of the assets. The authority to purchase expires two years from date of enactment.

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