In the wake of the 2008 financial crisis, the US government implemented the Dodd-Frank Act in order to better regulate the behavior of banks and to protect consumers. The Dodd-Frank Act became one of the most important articles of US financial legislation, introducing significant new compliance obligations for banks and other financial institutions.
What is the Dodd-Frank Act?
The Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly referred to as Dodd-Frank) was signed into law by President Obama on July 21st, 2010. The Act was named for its proponents, Senator Chris Dodd, and Congressman Barney Frank, and received bipartisan support.
Dodd-Frank was intended to restore confidence in the US financial system, avoid a repeat of the 2008 crisis, and end the era of taxpayer-funded bailouts for ‘too big to fail’ banks. With that in mind, Dodd-Frank introduced a range of regulatory changes designed to improve the stability and oversight of banks and financial institutions, including 243 new compliance rules for firms operating in the financial sector.
Dodd-Frank eliminated ineffective regulatory agencies, introduced new agencies, and merged others. The US Office of Thrift Supervision, for example, was eliminated, with its responsibilities transitioned to the Federal Deposit Insurance Corporation (FDIC). Similarly, Dodd-Frank created a number of new agencies: the Consumer Financial Protection Bureau (CFPB) was created to provide oversight for credit card and mortgage crimes, while the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) were created to ensure that financial institutions would not need to be bailed out by the US government.
Under new rules, all regulatory agencies are required to submit annual reports to Congress detailing their accomplishments over the past 12 months, and setting out their goals for the next
In addition to reporting requirements, Dodd-Frank also introduced a requirement for banks and financial institutions to conduct annual stress tests in order to prepare for unforeseen adverse situations and crises. The stress tests entail hypothetical financial scenarios that allow firms to explore their ability to maintain stability when facing challenges.
Where the stress tests reveal weaknesses or vulnerabilities, the Federal Reserve may take certain actions, such as capping share dividends, to ensure the firm in question can weather any sustained negative effects.
High Risk Derivatives:
Under Dodd-Frank, the Securities and Exchange Commission (SEC) was given the authority to regulate the trade of derivatives which, in practice, includes the exchange of stocks, bonds, commodities, and currencies.
Where those instruments are found to present high levels of risk, the SEC can take action to prevent financial institutions from creating new crises.
Federal Reserve Act:
Dodd-Frank amended the Federal Reserve Act to strengthen the new regulatory standards that it introduced. The amendments specifically addressed loopholes that had contributed to the 2008 financial crisis, and the recession that followed.
The Dodd-Frank Act strengthened the Sarbanes-Oxley Act which sets out rules regarding CEOs’ personal responsibilities for accounting errors, and for the protection of corporate whistleblowers.
Under Dodd-Frank, the statutory limit for an employee submitting a claim against their employer was increased to 180 days (from 90). The Act also established a bounty reward program, entitling whistleblowers to up to 30% of the settlement proceeds of successful litigations against companies that violate financial regulations.
Certain non-financial institutions must abide by Dodd-Frank regulations. Specifically, institutions such as insurance agencies and currency exchanges that carry out large transactions and play an important role in the US economy must comply with federal compliance rules.
The Volcker Rule:
Dodd-Frank introduced the Volcker Rule which prevents banks from engaging in the kind of speculative trading that created the 2008 crisis. The rules prohibited banks from using or owning hedge funds for profit, and prevented the purchase and sale of securities, derivatives, commodity futures, and options.
Under the Volcker rule, banks may only trade with these instruments with the permission of their customers.
Hedge Fund Registration:
The mismanagement of hedge funds was a significant contributing factor to the financial crisis. Accordingly, Dodd-Frank introduced a requirement for hedge funds to register with the SEC and provide a range of information about their business practices, including trades and portfolios.
Criticism and Roll-Back:
Like other legislation aimed at significant financial reform, Dodd-Frank has faced broad criticism. Many opponents argue that the Act does not go far enough to prevent another financial crisis while its reforms do little to decrease the likelihood of banks and financial institutions needing government bailouts in the future. By contrast, some Dodd-Frank critics argue that the Act’s regulatory reforms are too stringent and infringe on the Constitutional rights of financial institutions.
Under the Trump administration, certain aspects of Dodd-Frank were rolled back. In 2018, President Trump signed a bill that exempted smaller and regional banking institutions from the Volcker Rule, and increased the amount of assets that certain financial institutions could hold before becoming ‘too big to fail’ and requiring government bailouts.
Despite efforts to amend the scope of Dodd-Frank, as of 2021 major aspects of the Act remained in place.
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