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Notrh, Gill; Buckley, Ross --- "The Dodd–Frank Wall Street Reform and Consumer Protection Act Will Require a Change in Regulatory Culture and Mindset to be Effective" [2011] UNSWLRS 52

Last Updated: 22 December 2011

The Dodd–Frank Wall Street Reform and Consumer Protection Act Will Require a Change in Regulatory Culture and Mindset to be Effective

Gill North, University of New South Wales*
Ross Buckley, University of New South Wales[&]


This paper is to be published in 35(2) Melbourne University Law Review (2011) (forthcoming). This paper may also be referenced as [2011] UNSWLRS 52.


The Dodd-Frank Act constitutes the most significant reform of financial regulation in the United States since the 1930s. Some of its provisions are bold, particularly in the areas of consumer protection and derivative trading. However, the political challenges for law reformers and regulators in the wake of the global financial crisis are far from over. The Act is inchoate. The full scope and nature of the new financial regulatory system will take several years to evolve as the mandated studies and rule making are completed and implemented. We argue that the extent to which the reforms achieve their stated objectives will depend most critically on three factors: (i) the competency, integrity and forcefulness of the federal regulators, (ii) their ability and willingness to supervise the finance industry on an integrated basis, and (iii) a fundamental change in the regulatory culture and mindset.

The Global Financial Crisis (GFC) led to widespread calls for regulatory change in the United States (US) and elsewhere. In June 2009, President Barack Obama introduced a proposal for a ‘sweeping overhaul of the United States financial regulatory system, a transformation on a scale not seen since the reforms that followed the Great Depression.’[1]

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Pub L 111-203, 124 Stat 1376) (‘The Act’) was signed into law by President Obama on July 21, 2010. The Act is named after two members of Congress, Representative Barney Frank who proposed the bill in the House on December 2, 2009 and Chris Dodd the Chairman of the Senate Banking Committee. Its stated purposes are:

The purposes of the Act reflect the major political and public concerns in the US during and in the wake of the crisis:

Most of the Act deals with these individual areas of concern.[2] However, the reforms also address factors that were generally acknowledged as significant underlying causes of the crisis, such as issues relating to the securitisation and derivative markets and credit rating agencies.

The potential scope of the Act is immense. The statute is nearly a thousand pages long and it encompasses many aspects of financial reform. One legal practitioner describes it as ‘a profound increase in regulation of the financial services industry’,[3] others as ‘a paradigm shift in the American financial regulatory environment affecting all Federal financial regulatory agencies and affecting almost every aspect of the nation's financial services industry.’[4] However, the Act is inchoate and provides only a broad framework. Some of the reforms came into effect the day following its passing into law.[5] However, the operation of many provisions is delayed or subject to rule making by the federal regulators. The regulators are required to conduct numerous studies and provide reports and recommendations in order to determine the provisions governing many of the most controversial reforms.[6] While most of the rulemaking was scheduled for completion within 12 months, the legislative timetables were overly ambitious.[7] The full scope and nature of the financial regulatory framework may take several years to emerge. Indeed, the efficacy of some of the regulation will only be known at the time of the next major financial crisis.

The importance of the legislation to financial regulation and economic development globally are hard to exaggerate. A significant proportion of the world’s financial services are provided in the US or by US based institutions. Moreover, as the GFC clearly highlighted, the world’s financial systems are inextricably interconnected. It is not feasible for a single paper to discuss the Act or critique its provisions comprehensively. Instead, the article provides an overview of the significant reforms and discusses some of the more controversial proposals. The primary aims are to highlight the incomplete nature of the legislation and the essential reliance on federal regulators to draft, implement, supervise and enforce the reforms.

The article discusses the financial regulatory structure initially. The Act provides the primary federal regulators, the Federal Reserve (the Fed), the US Department of the Treasury (Treasury), the Federal Deposit Insurance Corporation (the FDIC), the Securities and Exchange Commission (the SEC) and the Commodity Futures Trading Commission (the CFTC) with enlarged powers and functions.[8] However, the regulatory system remains cumbersome. The proposed reforms, far from streamlining the supervisory arrangements governing financial companies, add a layer and complexity to the multi agency framework.

The legislative reforms are then reviewed under the following categories: supervision of systemically important institutions, financial institutions, financial markets & products, executive compensation, consumer protection, and investor protection. These reviews outline the most important or significant provisions, followed by commentary and analysis. The aspirational objectives of the Dodd Frank Act are largely uncontroversial. Assessment of the regulation and provisions is more difficult given the inchoate nature of the legislation, the reliance on regulators to complete and manage the reform processes, and the need to assess the reforms using a long-term lens.

We complete the analysis with discussion on regulatory performance issues, because the ultimate success of the legislation relies on the regulators’ willingness and ability to manage the reforms as an integrated package, and to work together with a primary focus on the bigger picture. We argue that this requires more than simply legislative change. The real question posed by the reforms is not whether the regulators have sufficient powers to achieve the stated objectives of the Act, but whether they are willing to proactively use these powers to prevent, or to mitigate the negative effects of, the next financial crisis.[9]

A The Financial Regulatory Structure

There are many papers that detail the significant financial policy reforms and development of the regulatory framework in the US since the 1930’s.[10] In 2009 the Government Accountability Office (GAO), which acts as an independent review agency of Congress, indicated that the ‘current US financial regulatory system ... [is a] fragmented and complex arrangement of federal and state regulators – put into place over the past 150 years – that has not kept pace with major developments in financial markets and products ... [R]esponsibilites for overseeing the financial services industry are shared among almost a dozen federal ... regulatory agencies ... and hundreds of state financial regulatory agencies.’[11] Hubbard suggests the ‘fragmentation of regulators is not the product of careful design – it has evolved by layers of accretion since the Civil War. It has survived largely unchanged, despite repeated unsuccessful efforts at reform.’[12] Kushmeider indicates that ‘[m]ost observers of the US financial regulatory system would agree that if it did not already exist, no one would invent it.’[13] She suggests that repeated failures to reform the system show ‘how sensitive the issues are for the many varied interest groups involved’.[14]

The financial regulatory structure in the US prior to the Act has been described as “functional”, with financial products or activities regulated according to their function. The benefits of this structure were seen to be:

• a better understanding of products or activities due to regulator specialisation;

• improved regulatory innovation due to competition among regulators;

• checks and balances between the regulators;

• the ability for companies to select the regulator most appropriate for their business; and

• a system that has generally worked well, enabling deep, liquid and efficient markets.

However, those seeking reforms argued that the multi-agency structure resulted in:

• overlapping jurisdictions making it difficult to hold any one agency accountability for its actions;

• conflicts between state and federal regulators;

• potential regulatory gaps;

• competition between regulators in a race to the bottom for the lowest regulatory standards and lax enforcement;

• the inability for regulators to manage complex financial institutions or systemic risk;

• difficulties managing consolidated groups; and

• entrenched constituencies.

An IMF report in August 2007 indicated that the multiple federal and state regulatory frameworks in the US overseeing the financial market system may limit regulatory effectiveness and slow responses to pressing issues. Two months later the GAO reported to Congressional Committees on the federal regulatory system.[15] The GAO report indicated that the regulatory structure was challenged by the developing industry trend of large, complex, internationally active firms whose product offerings span the jurisdiction of several agencies. It highlighted unresolved issues around duplicative and inconsistent regulation of financial services conglomerates and problems with accountability when agency jurisdiction is not clearly assigned. A GAO report released as testimony before the Committee on Homeland Security and Governmental Affairs of the US Senate in January 2009 reached a stronger conclusion. The summary stated that ‘[a]s the nation finds itself in the midst of one of the worst financial crises ever, the regulatory system increasingly appears to be ill-suited to meet the nation’s needs in the 21st century.’[16] The limitations and gaps posed by the fragmented regulatory arrangements were identified as:

1. A failure to mitigate systemic risk posed by large and interconnected financial conglomerates;

2. Difficulties in dealing with significant market participants - such as nonbank mortgage lenders, hedge funds and credit rating agencies;

3. Challenges posed by new and complex investment products such as complex retail mortgage and credit products;

4. Difficulties in establishing accounting and audit standards that are responsive to financial market developments and global trends; and

5. Difficulties in coordinating international regulatory efforts.[17]

The 2009 GAO report did not provide detailed proposals or solutions to address the identified issues; instead it outlined principles that an ideal regulatory framework should reflect. It indicated that the framework should: have clearly defined regulatory goals; be comprehensive; adopt a system wide focus; be efficient and effective; ensure consistent consumer and investor protection; ensure that regulators are independent with sufficient resources, clout and authority; and ensure consistent financial oversight with minimal taxpayer exposure.[18]

The reforms outlined in the following sections include provisions to address the issues identified by the GAO excepting the accounting and audit standard difficulties. Whether these reforms will result in the ideal regulatory system proposed by the GAO remains an open question.

B Supervision of Systemically Important Financial Institutions

1 The Act

(i) Financial Stability Oversight Council

President Obama wanted to limit the overall size of individual financial institutions to avoid a concentration of risk in a small number of financial companies and to reinforce the principle that no institution is too big to fail. This aspiration is translated into provisions that potentially require systemically important companies to hold minimum levels of risk based capital beyond those generally applicable under other regulation.[19] Banks holding companies with $50 billion or more in assets and nonbank financial companies designated as systemically important (designated NFCs)[20] can be made subject to “enhanced prudential” requirements beyond those imposed by other regulation. Individual regulators are authorised to determine the specific leverage and capital measures.[21]

The Fed is also empowered to act in relation to bank holding companies with $50 billion or more in assets and systemically important NFCs that pose a ‘grave threat to the financial stability of the United States’.[22] The Fed may: limit the ability to merge with, consolidate or affiliate with another company; restrict the financial products offered; require the termination of activities; impose conditions on the way a business activity is conducted; or require the selling or transfer of assets.[23] In addition, mergers, acquisitions and other business combinations are prohibited if the resulting enlarged company would hold more than 10% of the total consolidated liabilities of all banks and supervised NFCs.[24]

The reforms extend beyond concern with individual financial institutions to the supervision of systemic risk and financial stability. The Fed remains primarily responsible for the systemic risk regulation and supervision. In addition, the Act establishes a Financial Stability Oversight Council (Council), which includes representatives from all of the major regulatory bodies,[25] to identify risks to the financial stability of the United States, to promote market discipline, and to respond to emerging threats.[26] The role of the Council is to provide advice, communication and coordination across the regulatory framework. It is required to define and monitor systemic risk regulation, conduct research, keep abreast of ongoing market developments, and to make recommendations on prudential standards and market activity.

(ii) Orderly Liquidation Authority

Title II of the Act creates an Orderly Liquidation Authority (OLA) that empowers the FIDC to serve as a receiver for large interconnected financial companies whose insolvency poses a significant risk to financial stability or is likely to seriously adversely affect the US economy.[27] As receiver of a financial company, the FIDC assumes control of the liquidation process with broad powers.[28]

The Act prevents the use of taxpayers’ funds to pay for any aspect of the receivership process.[29] All costs are to be recouped from creditors or shareholders of the institution,[30] from the disposition of assets of the company, or from assessments on other financial companies.[31]

2 Commentary & Analysis

The reforms in Titles 1 and II of the Act reflect elements of proposals put forward by some scholars. Herring argued in 2009 that ‘supervisors need to place much greater emphasis on increasing the resilience of the system by ensuring that no institution is too big, too complex, or too interconnected to fail.’[32] He suggested that systematically important institutions should be required to file and update a winding-down plan and where required, supervisors should be empowered to require changes in the size or structure of firms.

Skeel argues that the final reforms single out the largest institutions for special treatment. He suggests the OLA processes provide ‘unconstrained regulatory discretion’ with the ‘basic expectations of the rule of law – that the rules will be transparent and knowable in advance ... are subverted by this framework.’[33] Taylor argues that OLA institutionalises a harmful bailout process because it is not possible for the FIDC to wind down large complex financial institutions without disruption. He criticises the significant discretionary powers given to the FIDC and suggests the problems of “too big to fail” and the political and regulatory capture by certain large financial institutions will continue.[34]

Wilmarth concludes that the too-big-to-fail (TBTF) policy remains ‘the great unresolved problem of bank supervision’.[35] He suggests the Act makes meaningful improvements in the regulation of large financial conglomerates. However, it does not solve the TBTF problem because: (i) it relies primarily on capital based regulation, the same supervisory tool that failed to prevent the 1980s savings and thrift crisis and the recent crisis; (ii) the efficacy of the supervisory reforms depend on the same federal regulatory agencies that failed to stop excessive risk taking during both crises; and (iii) the effectiveness of the Council is open to question given the history of turf wars and bureaucratic issues that have typically been associated with governmental multiagency oversight bodies in the US.[36]

The arguments of Skeel, Taylor and Wilmarth are valid. The Fed, the Council and the FIDC are given broad discretion to supervise and monitor the largest financial institutions, leaving the door ajar to regulatory abuse or capture.[37] In practice, the Federal Reserve is only likely to use its powers under section 121(a)(4) to break-up a systemically important financial institution in extraordinary circumstances.[38] Successful implementation of the OLA provisions will also be difficult, and the skill and competency of the regulators will be significantly challenged. Determinations on the appropriate time to positively intervene and break up or assume control of a company will be complex, confronting and intensely political decisions.[39] If the regulatory agencies take a conservative approach, the break up or winding down of a large firm may be too late to avoid another major crisis with potentially significant economic consequences. Conversely, the premature or poorly managed break up or winding down of an important firm is likely to be politically very costly.

Perhaps the weakest aspect of the reforms in Titles 1 and 2 is the domestic focus. One of the most important lessons from the GFC was the essential interconnectedness of global financial markets and systems. The GFC was primarily rooted in factors originating in the US. However, the circumstances of the next global financial crisis may be driven from elsewhere. Many of the largest financial institutions operate outside of the US and will not be subject to these provisions. Thus, the Fed, the Council and the FIDC need to work closely with global policy makers and regulators to ensure the reforms achieve their purposes. The efficacy of the provisions and processes in Titles 1 and 2 will only be seen fully in the next financial crisis.

C. Financial Institutions

The Act extends the breadth of the regulatory framework. The primary aims of the extended regulatory oversight are to restrict the scope of activity of some financial institutions as a means of reducing systemic risk and increasing the transparency of capital market trading.

1 The Act

(i) Insurance Companies

The insurance regulatory framework in the US is generally state-based. However, the ability of the Council to designate an insurance company as a significant NFC brings the insurance holding company system within the federal regulatory framework. In addition, Title V of the Act creates a Federal Insurance Office within Treasury to monitor all aspects of the insurance sector.[40]

(ii) Depository Institutions

The Act emphasises the traditional role of banks and saving and loan entities as intermediators between depositors and mortgagors. Section 619 prohibits depository institutions and their affiliates from engaging in proprietary trading; or acquiring or retaining an interest in a hedge fund or a private equity fund, or sponsoring such a fund.[41] These provisions (commonly referred to as the Volcker Rule, after former Chairman of the Federal Reserve, Paul Volcker) apply to proprietary trading and fund activities by US banks in any location. They also apply to proprietary trading and fund activities of non-US banks in the US, or such activities outside of the US if they involve the offering of securities to US residents. Designated NFCs are not subject to the Volcker Rule, but they may be required to hold additional capital and quantitative limits may be set in relation to such activities.[42]

“Proprietary trading” is broadly defined in the Act as engaging as a principal for the trading account of a banking organisation or supervised NFC in ‘any transaction to purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any security, derivative, or contract, or any other security or financial instrument’ that the Regulators may determine by rule.[43] In other words, the Volcker Rule generally prohibits the buying and selling of securities as principal for the entity’s trading account. However, some trading activity is specifically permitted, including:

The Act requires the Council to study the Volcker Rule and to make recommendations on its implementation.[45] The Council completed this study and reported to Congress on 18 January 2011.[46] The Council Report advocated robust implementation of the Volcker Rule and recommended that the federal regulatory agencies consider taking the following actions:

  1. Require banking entities to sell or wind down all impermissible proprietary trading desks.
  2. Require banking entities to implement a robust compliance regime, including public attestation by the chief executive officer of the regime‘s effectiveness.

3. Require banking entities to perform quantitative analysis to detect potentially impermissible proprietary trading without provisions for safe harbors.
4. Perform supervisory review of trading activity to distinguish permitted activities from impermissible proprietary trading.
5. Require banking entities to implement a mechanism that identifies to agencies which trades are customer-initiated.
6. Require divestiture of impermissible proprietary trading positions and impose penalties when warranted.
7. Prohibit banking entities from investing in or sponsoring any hedge fund or private equity fund, except to bona fide trust, fiduciary or investment advisory customers.
8. Prohibit banking entities from engaging in transactions that would allow them to “bail out” a hedge fund or private equity fund.
9. Identify “similar funds” that should be brought within the scope of the Volcker Rule prohibitions in order to prevent evasion of the intent of the rule.
10. Require banking entities to publicly disclose permitted exposure to hedge funds and private equity funds.[47]

Timothy Geithner, the Treasury Secretary who leads the Council, indicated that ‘we have to be careful to strike the right balance between putting in place new rules that protect consumers and investors and the economy, without stifling the competition and innovation that drives economic growth.’[48]

(iii) Hedge Funds & Private Equity Funds

Registered hedge fund advisers are subject to the same disclosure requirements as other registered investment advisers in the US. However, prior to the GFC, most hedge funds: were not registered with the SEC; were exempt from investment company and investment advisor registration; and were not required to report quarterly.[49] Regulators were ‘satisfied that there [was] no need for more intensive investor-protection regulation affecting hedge funds, because investors in such funds [were] high income individuals or institutions that [could] fend for themselves.’[50]

Registration with the SEC was not required because the funds were within the safe harbour of Regulation D under the private offering exemption of Section 4(2) of the Securities Act of 1933.[51] Most funds were exempt from registration as investment companies under Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940 as the securities were issued as private placements, and there was either less than 100 investors or the securities were offered to “qualified purchasers”. Section 203(b)(3) exempted advisors from registration under the Investment Advisors Act of 1940 provided there were fewer than 15 clients, no services were offered to the public, and no advice was given to registered investment companies.

The Act requires hedge funds and private equity funds that were previously exempt under Section 3(c)(1) or 3(c)(7) of the Investment Company Act, to register with the SEC.[52] In addition, the exemption under s 203(b)(3) of the Investor Advisers Act has been repealed, and all advisors to private funds, whether registered or not, are required to provide ongoing reports to the SEC.[53]

(iv) Credit Ratings Agencies

Section 931 of the Act indicates that Congress found that credit rating agencies are ‘central to capital formation, investor confidence, and the efficient performance of the United States economy’. The rating agencies ‘play a critical “gatekeeper” role in the debt market that is functionally similar to that of securities analysts ... and auditors ...’ Their activities are ‘fundamentally commercial in character and should be subject to the same standards of liability and oversight as apply to auditors, securities analysts, and investment bankers’. Inaccurate ratings on structured financial products ‘contributed significantly to the mismanagement of risks by financial institutions and investors ... Such inaccuracy necessitates increased accountability on the part of the credit rating agencies’.

The Act seeks to minimise conflicts of interest and improve the transparency of credit ratings processes by imposing corporate governance processes, and disclosure, reporting and procedural regulation. Disclosure is required of credit rating assumptions, procedures and methodologies; the potential limitations of a rating; information on the uncertainty of a rating; the extent to which third party services have been used in arriving at the rating; an overall assessment of the quality of available and considered information; and information relating to conflicts of interest.[54] A standardised form must be used to disclose the information to enable comparability.[55] The agencies must consider credible information from sources other than the product issuer.[56] The findings and conclusions of any third party due diligence report must be published and the third party must certify and explain the extent of the review performed.[57] The SEC is also mandated to establish a rule requiring agencies to provide published periodic performance reports that reveal the accuracy of ratings provided over a range of years and for a variety of types of credit ratings.[58]

The Act specifically provides for private investor actions against a credit ratings agency under the Securities Exchange Act of 1934, in the same manner and to the same extent as apply to statements made by an accounting firm or a securities analyst.[59] It also alters the pleading standards under the Private Securities Litigation Reform Act of 1995 so that a complaint need only state facts that give rise to a strong inference that the ratings agency knowingly or recklessly failed to conduct a reasonable investigation of the facts relied on or failed to obtain reasonable verification of the factual elements.[60]

The Act mandates the SEC to conduct a range of studies on, among other issues:

The SEC is empowered to enact a rule that requires the SEC to nominate a ratings agency if the study finds such a requirement is necessary or appropriate in the public interest or for the protection of investors, so as to prevent issuers playing agencies off against each other and ‘shopping’ for favourable ratings.[64]

2 Commentary & Analysis

(i) Volcker Rule

Prior to the GFC, the concept and practical reality of what constituted a bank, a nonbank financial institution, an insurance company, a hedge fund, a fund manager, a private equity advisor or a broker in the US had become blurred with the advent of large financial conglomerates. Significant areas of activity of many financial institutions, particularly the largest players, didn’t fit neatly within the jurisdictions of single regulators. Moreover, some areas of financial market activity, such as private equity and over-the-counter (OTC) trading, and some market participants, such as credit rating agencies and hedge funds advisors, were either not regulated at all or only minimally regulated.

The Volcker Rule represents a partial policy reversal to the period from 1933 to 1999 when the US had Glass-Steagall restrictions[65] in operation. These rules were initially introduced in the Banking Act of 1933, which generally prohibited:

These rules to effectively separate the businesses of commercial banking and investment banking or banking and securities activities were extended in 1956 by the passing of the Bank Holdings Company Act.[70] However, restrictions on the integration of banking and securities businesses were gradually relaxed from the 1970s, until formal repeal of the Glass-Steagall measures by the Gramm-Leach-Bliley Act of 1999.

Some scholars suggest it is surprising that opposition to repeal of the Glass Steagall restrictions was not stronger.[71] However, deregulation in the 1980s and 90s was strongly supported by most policy makers, scholars and the judiciary, as well as the finance industry. Most of the theories to support the push for increasing deregulation and ever-larger financial conglomerates were economic or efficiency based. The commonly cited arguments for larger and more integrated global financial institutions (or universal banking as it is sometimes called) were scale and diversification benefits, and the need to enhance efficiency, to spread risk, and to foster innovation. There were critics who warned about the potential concentration of risk.[72] However, these parties often failed to express their arguments in compelling economic terms, and when they did so, their voices were generally overwhelmed in the drive for new financial and economic growth and enhanced competitiveness or dominance on the global financial stage.

The size and scale of financial institutions are not the only factors that have changed significantly since the 1980s. The structure of capital markets and trading patterns have also undergone a series of transformative phases.[73] Market activity levels have rapidly escalated, particularly trading in derivative instruments.[74] An increasing proportion of this activity is computer generated ‘high frequency’ trading.[75] Mary Shapiro, the Chairman of the SEC recently testified that

proprietary trading firms play a dominant role by providing liquidity through the use of highly sophisticated trading systems capable of submitting many thousands of orders in a single second. These high frequency trading firms can generate more than a million trades in a singe day and now account for more than 50 percent of equity trading volume.[76]
It is never easy, and often not possible, to turn the clock back. Institutions will look for ways to continue trading under the new regime. The extent to which the Volcker Rule effects trading activity in the US and reduces potential systemic risk will depend on how the provisions are interpreted and enforced by the regulators and judiciary. The regulators are being asked to tread a fine line. The initial step of defining “proprietary trading” is difficult enough. Implementing and monitoring the Volcker Rule across varying markets, assets and institutions in an environment subject to constant change will be even more challenging.[77]

The broader impacts of the trading restrictions are uncertain. Ultimately, the Volcker Rule is only likely to be effective as a global strategy. If other major markets fail to adopt and enforce equivalent rules, institutions are likely to take advantage of gaps or weaknesses in the provisions and regulatory frameworks to move their trading to areas where proprietary trading is not restricted or oversight is limited.

(ii) The Hedge Fund Provisions

The benefits and risks posed by the hedge fund industry and the case for more regulation continue to be hotly debated. No evidence has been found suggesting that hedge funds were a direct casual factor of the GFC. However, as Eichengreen and Mathieson highlight, each crisis or episode of volatility in financial markets brings the role played by the hedge fund industry in financial market dynamics to the fore.[78] Hedge funds were implicated in the 1992 currency crisis in Europe. Similarly, there were allegations of large hedge fund transactions in various Asian currency markets in the lead up to, and in the wake of, the Asian financial crisis in 1997. These concerns were compounded by the near collapse of a major hedge fund, Long Term Capital Management in the US and more recent problems with hedge funds tied to subprime mortgages.

The absolute level of global trading by hedge funds continues to grow, representing an increasing proportion of total market trading.[79] Many hedge funds trade primarily in derivative instruments, which ‘compounds problems of information and evaluation for bank management, [other investors] and supervisors alike’.[80] These issues become more acute on a global basis. It is therefore important that hedge fund activities are encompassed within the regulatory structure to allow supervisors a comprehensive overview of markets.

(iii) The Rating Agency Provisions

Some scholars argued prior to the GFC that rating agencies were sufficiently motivated ‘to provide accurate and efficient ratings because their profitability is directly tied to reputation’.[81] Schwarcz concluded that ‘public regulation of ratings agencies [was] an unnecessary and potentially costly policy option.’[82] However, the public listing of a ratings company results in an inherent conflict between the managerial incentive to provide paying clients with their desired ratings, and to thereby increase the level of ratings provided and company profits, and the public interest that requires accurate ratings. Listokin and Taibleson propose an incentive scheme in which ratings are paid for with the debt rated.[83] This proposal is novel and interesting, but is unlikely to be acceptable to the agencies because it would make financial management of the company very difficult. Hunt argues that the ‘incentive problem can be corrected by requiring an agency to disgorge profits on ratings that are revealed to be of low quality by the performance of the product type over time, unless the agency discloses that the ratings are of low quality.’[84] This approach poses significant implementation issues. It is not clear who would make the ex post judgments on the quality of the ratings. There may be a range of factors resulting in poor performance that were not reasonably foreseeable by the rating agencies. Moreover, even when issues associated with the ratings quality could be directly linked to the agency, a disgorgement of the agency profit after the event would not assist investors who had suffered damage arising from the poor quality rating.[85]

Coffee suggests that analysis of the reforms relating to credit rating agencies requires acknowledgement of three simple truths: (1) an “issuer pays” business model invites the sacrifice of reputational capital in return for high current revenues; (2) ratings competition is good, except when it is bad; and (3) in a bubbly market, no one, including investors, may have a strong interest in learning the truth. He concludes that only a strong and highly motivated watchdog can offset this process of repression and self-delusion.[86] Coffee argues that reform that fails to address the “issuer pays” business model ‘amounts to re-arranging the deck chairs on the Titanic, while ignoring the gaping hole created by the iceberg.’[87] He emphasises the importance of getting the regulation right and suggests it is necessary to encourage a “subscriber pays” model[88] to compete with the “issuer pays” model. A mandated subscriber pays model is worthy of further consideration as the reforms included in the Act, which predominantly rely on disclosure rules, may not be adequate to address the strong temptation for agencies to prefer short term profits over longer term reputational issues.[89]

Finally, there are questions around the constitutionality of the provisions enabling private investor actions against credit ratings agencies. Litigation against the ratings agencies has generally been unsuccessful in the United States because the courts have upheld the agencies claim for protection under the First Amendment of the Constitution, on the basis that their ratings are statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities.[90]

D Capital Markets & Products

1 The Act

(i) Securitization

The Act seeks to enhance the accountability and diligence of parties issuing or originating asset backed securities (ABS) by requiring them to retain some of the credit risk (to keep some “skin in the game”). The retained risk may not be hedged or transferred.

The required risk retention is a minimum 5 percent. However, assets that are not subject to the retained risk requirement include securitization of “qualified residential mortgages”, securitization of federally guaranteed mortgage loans, and other assets issued or guaranteed by the US and its agencies.[91] These provisions are a good example of the incomplete nature of this legislation, as the definition and standards of a “qualified” residential mortgage are to be determined by the Federal banking agencies, the SEC, the Secretary of Housing and Urban Development and the Director of the Federal Housing Finance Agency.[92]

An issuer of ABS must disclose asset or loan level data on the identity of brokers or originators of the assets, compensation of the brokers or originators, and the amount of risk retained if this is required for investors to carry out independent due diligence.[93] ABS credit ratings must provide a description of the representations, warranties and enforcement mechanisms and how they differ from issuances of similar securities.[94] Disclosure of fulfilled and unfulfilled repurchase requests is required so that investors can identify underwriting deficiencies.[95] The Act mandates the SEC to issue rules requiring issuers of ABS to conduct a review of the underlying assets and to disclose the outcome to investors.

(ii) Derivatives & Swap Trading

Title VII of the Act entitled ‘Wall Street Transparency and Accountability’ extends regulatory oversight to OTC derivatives and markets. The new regime encompasses commodity swaps, interest rate swaps, total return swaps and credit default swaps. The CFTC is responsible for regulating swaps, while the SEC is responsible for the regulation of security-based swaps,[96] with the definitions of “swaps” and “security-based swaps” leaving ambiguities that will need to be resolved.[97] Foreign currency products other than spot and exchange-traded contracts will be subject to CFTC supervised regulation. Any security-based swap that contains an interest rate, currency or commodity component will be subject to regulation by both the CFTC and SEC, in consultation with the Fed.

The stated purposes of the reforms are to increase the transparency, liquidity and efficiency of OTC derivatives markets and to reduce the counterparty and systemic risk. The adopted mechanisms to achieve these goals are:

The Act requires the SEC and the CFTC to establish detailed mandatory clearing processes, business conduct standards, and capital and margin requirements. The Act empowers the CFTC and SEC to clear a swap or to require designated swaps to be cleared.[101] This means that swaps that are subject to mandatory clearing requirements but which clearing houses determine are not eligible for clearing will effectively be prohibited. A swap is exempt from the clearing and exchange trading requirements if one of the counterparties is an end user that is hedging commercial risk. However, the exemption only applies to a counterparty that is not a financial entity; that is using swaps to hedge or mitigate commercial risk; and that notifies the SEC how it generally satisfies its swap related financial obligations.[102] The CFTC and SEC are required to create rules to mitigate conflicts of interests arising from control of clearing houses, exchanges and swap facilities by industry participants.[103]

All swap dealers and major swap participants are subject to risk-based capital requirements.[104] In addition, the Act provides the CFTC with powers to impose aggregate position limits across markets in order to:

Similarly, the SEC may establish size limits on individual or aggregate swap positions as a means to prevent fraud and manipulation.[106]

Finally, the SEC is mandated to adopt business conduct standards requiring swap dealers and participants to disclose material risks and characteristics of a swap, material incentives or conflicts of interest, and mark-to-market information.[107] When advising special entities such as municipalities and pension plans, swap dealers have a duty to act in the best interests of the special entity.[108] A duty must also be established requiring swap dealers or major participants to ‘communicate in a fair and balanced manner based on principles of fair dealing and good faith.’[109]

(iii) Payment, Clearing and Settlement Activities

The Act provides for the supervision of systemically important financial market utilities and payment, clearing and settlement activities conducted by financial institutions. The CFTC and the SEC are required to enact regulation in consultation with the Council and the Fed containing risk management standards for designated utilities and activities.[110] The standards to be considered include:

2 Commentary & Analysis

The Act does not prohibit or limit specific types of derivative instruments such as synthetic Collateralised Debt Obligations (CDOs) that attracted much adverse comment in the aftermath of the GFC. Instead, the CFTC and SEC are empowered to report on any instruments that may undermine the stability of a financial market or have adverse consequences for participants in the market.[112] This approach acknowledges that capital markets are constantly evolving, and that to be effective, regulation and regulatory responses must adapt to changing conditions and product innovation. The legislative reforms will only be meaningful if they deter or mitigate the fallout from the next financial crisis, which will almost certainly centre on different products and circumstances than those leading up to the GFC.

The intended effect of the swap related provisions appears to be to encourage standard or vanilla type swaps that are cleared through an exchange and clearinghouse in order to improve systemic oversight. Clearinghouses generally manage default risk by netting offsetting transactions, by collecting an upfront margin on trades that serve as a reserve in the event of default by a member, and by the establishment of a guarantee fund to cover losses that exceed the margin collected. On products such as swaps and commodities, the collateral generally includes an ongoing variation margin. The Act replicates this model by requiring margin payments by swap counterparties outside of clearinghouses such as transactions through the OTC markets. The collateral, margin and disclosure requirements are likely to promote greater use of standardised structured products and vehicles and discourage more complex and highly leveraged structures.

Many parties have argued for greater transparency in post GFC securistisation and derivative markets.[113] Some argue that the reforms do not go far enough. For instance, some suggest that naked credit default swaps should be banned. Others suggest the provision exceptions are too broad and as a consequence, a large portion of the derivative trading will continue unhindered.[114] Skeel concludes that despite the substantial uncertainties in the legislation, the new framework for clearing derivatives and trading them on exchanges ‘is an unequivocal advance’.[115] We agree. When trades are cleared through clearing houses, the risk of default is independently managed and minimised. To the extent the reforms encourage derivative trades through exchanges rather than OTC markets, market transparency and regulatory scrutiny are likely to be significantly improved Global supervisors need ready and regular access to derivative trading positions to understand capital market developments and to determine systemic risks. Consequently, these reforms may enhance the operation of markets and long-term economic efficiency.

Nevertheless, the difficulties involved in monitoring global systemic risk should not be underestimated. Capital market trading in the US is highly fragmented across many exchanges, electronic communication networks, and broker dealers. The number of orders ‘executed in non-public trading venues such as dark pools and internalizing broker-dealers now account for nearly 30 percent of volume’.[116] The increasing prevalence of high frequency trading through direct access market providers makes it difficult and time consuming for regulators to identify trades and the traders involved. The reporting of trading activity even within the US ‘often has format, compatibility and clock-synchronization differences.’[117] These issues are significantly compounded when trying to determine global exposures. Regulators are improving their systems and audit trails in an endeavour to better monitor trading activity and market developments, but the continuing rapid growth of global trading activity make this an ongoing challenge.

E Executive Compensation

1 The Act

The reforms seek to address public concerns on compensation paid to company executives, particularly to managers of financial institutions. The Act requires enhanced disclosure and accountability on compensation paid to executives of listed companies. Shareholders are provided with a non-binding vote on some executive compensation issues including ongoing executive packages and golden parachutes.[118] Companies must explain the basis of the relationship between executive compensation and financial performance,[119] and disclose the ratio of the compensation of the Chief Executive to employee compensation.[120] In addition, incentive-based compensation paid to executives may be clawed back when based on financial reporting that is materially noncompliant with the securities laws.[121]

The more controversial provisions are contained in section 956. These provisions require the regulators to enact regulation prohibiting certain incentive-based compensation packages for executives or directors of bank holding companies and other “covered financial companies”.[122] The regulators must issue regulations “that prohibit any types of incentive-based payment arrangement ... that the regulators determine encourages inappropriate risks by covered financial institutions –

(1) by providing an executive officer, employee ... with excessive compensation, fees, or benefits; or
(2) that could lead to material financial loss to the covered financial institution.”[123]

The Fed, the FIDC, and the Office of the Comptroller of the Currency, which issued joint guidelines on executive remuneration in June 2010, will monitor compensation paid to bankers in the US. The regulators are also reviewing incentive practices at large financial institutions.

Notably, the Act requires the employment of management responsible for the financial condition of a failing covered financial company to be terminated.[124] The provisions also provide that ‘management, directors, and third parties having responsibility for the condition of the financial company bear losses consistent with their responsibility.’[125]

2 Commentary & Analysis

The legislators clearly want to be seen to potentially hold individuals that have presided over the collapse of financial companies personally liable for some of the losses. However, the provisions that seek to potentially clawback some of the compensation paid to managers, directors and third parties of failed covered financial companies, as well as reimbursement of some of the losses borne, are broad and imprecise and will require judicial interpretation.[126]

The likely outcomes from s 956 are also uncertain. The section prohibits any incentive-based compensation arrangement that (a) encourages inappropriate risk taking by providing excessive compensation to staff; or (b) encourages inappropriate risk taking that could lead to material financial loss for the institution. Accordingly, incentive-based compensation that is not excessive is still prohibited if it could lead to risks being taken sufficient to cause material losses. It will be interesting to see how the final rules define ‘excessive’ compensation and how the regulators will interpret the compensation arrangements that while not necessarily excessive still encourage material and inappropriate risk taking.

At a global level, the G20 finance ministers backed away from a joint pledge to cap bank bonuses in 2009.[127] However, on 8 July 2010 the European Parliament passed legislation limiting bonuses at banks, hedge funds and other financial institutions.[128] The new rules, which took effect from the beginning of 2011, require bonuses to be structured on a long-term basis, with restrictions on upfront cash bonuses, requirements to retain at least 50% of total bonuses for a period contingent on long term investment performance, and strict limits on compensation paid to the executives of institutions that were bailed out or supported using taxpayer monies.[129] The US may enact similar bonus restrictions. Some financial institutions in the US are pre-empting such a move and are deferring more than 50% of the bonuses awarded.[130]

F Consumer Protection

1 The Act

Title X of the Act, the Consumer Protection Financial Protection Act of 2010, creates and empowers a new and independent Consumer Financial Protection Bureau (CFPB) to develop consumer protection rules.[131] The purpose of the CFPB is to ‘seek to implement and, where applicable, enforce Federal consumer financial law consistently for the purpose of ensuring that all consumers have access to markets for consumer financial products and services and that markets for ... [these] products and services are fair, transparent and competitive.’[132] The definition of consumer financial products or services is broad, and includes credit cards, mortgages, credit bureaus, debt collection, and any product that a bank or financial holding company provides to consumers except insurance.[133]

The Act provides the CFPB with powers to issue regulations, to examine compliance, and to take enforcement action under federal financial consumer laws.[134] The CFPB has broad authority over depository institutions with assets in excess of $10 billion, other financial institutions that broker, originate or service mortgage loans, and other large participants that market consumer financial services.[135] The Bureau may prevent these institutions from engaging in unfair, deceptive or abusive practices in the provision of consumer financial products and services.[136]

The CFPB encompasses a research unit to monitor trends in the provision of consumer financial products, a Community Affairs Unit to focus on consumer education, and a centralised Complaints Unit.[137] It also includes the establishment of an Office of Fair Lending and Equal Opportunity,[138] an Office of Financial Education,[139] and an Office of Service Member Affairs.[140]

The Act aims to significantly strengthen mortgagee rights and protections. Title XIV of the Act, the Mortgage Reform and Anti-Predatory Lending Act, imposes new mortgage underwriting standards, prohibits or restricts specified mortgage lending practices and regulates payments to mortgage loan officers and brokers. Lenders are banned from steering consumers into high cost unaffordable loans. Lenders must verify a borrower’s ability to repay the mortgage in its entirety, including consideration and documentation of specified factors such as the borrower’s credit history, employment status, income, and debt-to-income ratio.[141] A borrower may raise a violation of these standards as a foreclosure defense.[142] However, there are safe harbour provisions relating to “qualified mortgages” that meet specified criteria, including points and fees of less than three percent of the total new loan amount.[143] In addition, intermediaries of mortgage refinancings must be able to show that borrowers are better off as a result of a refinancing. To better align intermediary incentives with those of their clients, compensation payments based on interest rate premiums (commonly referred to as yield spread premiums) or other terms of the loans other than the amount of the principal are prohibited.[144] Penalty provisions relating to prepayments of certain loans are also disallowed.[145] Notable enhancements to the mortgage disclosure rules include mandatory notice of resets of the interest rate and negative amortization occurrences.[146]

2 Commentary & Analysis

The development of credit consumer law in the US has a chequered history that is closely aligned to the property boom and bust cycles and changes in the institutional and product structures.[147] Up until the 1970s the savings and loans entities (S&Ls) were the major providers of mortgage credit. However, as the securitisation markets grew, the S&Ls lost market share to mortgage companies with access to cheaper funds. Financial deregulation shifted the mortgage industry to a predominantly national system, with mortgages provided on an originate-to-distribute model from mortgagee companies that were predominantly unregulated.[148]

During the 1980s and 90s consumer advocates highlighted issues around predatory and high cost lending and were successful in achieving some policy change.[149] However, there was intense lobbying from the finance industry opposing calls for a strengthening of consumer protection law.[150] Continuing issues around predatory lending resulted in a series of federal policy reviews. In 2000 the US Department of Housing and Urban Development and the US Treasury Department issued a report recommending that the Fed use its authority under the Home Ownership and Equity Protection Act (HOEPA) of 1994 more forcefully to deter predatory practices.[151] The Fed held hearings on potential reforms and recommended changes that potentially increased the number of loans subject to the Act. However, despite continued reviews and warnings from many quarters about the dangers of subprime loans and the increasing use of complex loan structures, lending regulation at a federal level was not substantially changed.[152] In addition, conflicts between state and federal regulators increased as federal regulators used their preemption powers to override enhancements to state mortgage regulation.[153] In 2007 the legitimacy of the preemption authority was tested in the Supreme Court in Watters v Wachovia Bank, N.A.[154] The Court held that the state regulators could not interfere with the “business of banking” of federally regulated institutions by subjecting national banks or their OCC-licensed operating subsidiaries to state audits and surveillance under rival oversight regimes.[155]

In 2007 the Fed held further hearings on subprime and predatory lending and proposed increased regulation. A bill containing more substantive protection for consumers was passed in the House in 2008.[156] This bill laid the groundwork for many of the provisions in the subsequent Act.

The establishment of an independent and well-resourced consumer protection regime that encompasses research, education, complaints and enforcement arms, provides a potentially powerful consumer advocate. Critics argue that the Consumer Bureau has been given too much power. Others suggest that consumer’s interests were woefully underrepresented during the crisis and the establishment of the CFPB is overdue and a step forward.[157]

A single consumer agency solution potentially addresses the argument that the prior architecture inevitably led to consumer protection falling through the cracks and taking a back seat to the agencies’ primary mission of financial safety and soundness.[158] One of the most tragic outcomes of the crisis in the US has been the large number of people forced from their homes due to mortgage defaults.[159] Bar-Gill and Warren concluded in 2008 that ‘[e]vidence abounds that consumers [were] sold credit products that [were] designed to obscure their risks and to exploit consumer misunderstandings.’[160] The evidence indicates that many of the practices adopted for selling financial products and services prior to the GFC had become abusive, and accountability and enforcement mechanisms across the financial intermediary industry were weak.[161] Numerous studies of the mortgage markets by government agencies and independent bodies during the 2000-2006 period found that a high proportion of those sold high interest rate subprime loans would have qualified for lower cost prime market loans.[162] In addition, scholarly and policy research found a correlation between unfair credit terms and minority status.[163] In 2000 the joint Department of Housing and Urban Development -Treasury Task Force on Predatory Lending warned

In some low-income and minority communities, especially where competition is limited, predatory lenders may make loans with interest rates and fees significantly higher than the prevailing market rates, unrelated to the credit risk posed by the borrower.[164]
In 2006 research on the Detroit area by the University of Michigan concluded that

... even within similar low-income neighbourhoods, black homeowners are significantly more likely to have prepayments penalties or balloon payments attached to their mortgages than non-black homeowners, even after controlling for age, income, gender and credit worthiness.[165]

A series of criminal and civil actions relating to mortgage practices have been settled, or are underway. For instance, Bank of America has reached a $US2.8 billion settlement with Fannie Mae and Freddie Mac over claims that Countrywide Financial, which Bank of America bought in 2008, routinely provided mortgages to parties who they knew could not afford them.[166]

In 2007 Warren proposed a new federal consumer protection agency to ensure minimum safety standards for all consumer financial products.[167] The Act seeks to provide such safety standards on mortgage products by encouraging the use of qualified or standardised mortgages rather than complex and expensive mortgage structures, and by discouraging the payment of excessive fees. Critics argue that the regulation will result in reduced product choice. However, the extent to which mortgagees benefit from sophisticated bells and whistles is debateable. In any event, the provisions as they stand currently do not prevent the design of flexible features into mortgage products.

The new CFPB is a bold reform. However, the practical benefits of the new regime to consumers will depend on: the new agency’s commitment to fairness in credit markets; the independence of the agency staff; the detailed final rules; and consistent enforcement of the measures adopted.[168] The history of consumer credit law in the US suggests the agency will be heavily pressured by industry to weaken the final rules and to supervise with a light touch.[169]

G Investor Protection

1 The Act

The Act clarifies the authority of the SEC to establish rules requiring disclosure prior to the purchase of financial products or services by retail clients.[170] The Act requires documents in a summary format that contain clear and concise information about the investment objectives, strategies, costs and risks, and any compensation or other financial incentive received by the intermediaries.[171] Rule development to encourage clear, concise and effective marketing and disclosure documentation prior to the sale of financial products and services is a regulatory approach that has been used for many years, arguably with some success, in other jurisdictions.[172]

The most contentious financial intermediary issues were left open to further investigation and consultation. The Act requires the SEC to review the duties and standards of care applying to brokers, dealers and investment advisors when providing personalised investment advice and recommendations in connection with the purchase of retail investment products.[173] While the SEC is given the power to establish a fiduciary standard, [174] clients may consent to material conflicts of interest if these are adequately disclosed.[175]

The SEC is mandated to study a number of financial intermediary issues, including: how to improve investor access to intermediary registration information;[176] the need for greater regulatory oversight and enforcement of financial service intermediaries;[177] and whether to restrict or prohibit certain sales practices, conflicts of interest, and intermediary compensation schemes that are deemed detrimental to the public interest and investor protection. The GAO is required to study mutual fund marketing[178] and potential conflicts of interest if these are adequately disclosed.[179]

Regulation to enhance protection for direct investors (that is, investors who invest in securities without intermediary assistance) has also been strengthened. The Act establishes a new Investor Advisory Committee,[180] an Office of the Investor Advocate[181] and a retail investor Ombudsman.[182] The Advisory Committee, which represents retail and institutional investors, will advise and consult with the SEC on:

The Investor Advocate will identify regulatory issues and problems specifically affecting retail investors.[184] The new Ombudsman will act as mediator between retail investors and the SEC.[185]

The SEC enforcement powers have been strengthened. The SEC may pay significant monetary amounts to individuals who provide information that leads to a successful SEC enforcement action.[186] Monetary penalties may be imposed in administrative cease-and-desist proceedings against a person for a violation of securities regulation.[187] In addition, the rules, penalties, and standards on aiding and abetting have been significantly enhanced.[188]

Finally, the Act tightens the rules on short selling. Monthly public disclosure on short positions is required,[189] and short selling that is deemed to be manipulative is prohibited.[190]

2 Commentary & Analysis

(i) Intermediary Conflicts of Interest

There are no easy regulatory or empirical solutions to issues around how to best deal with financial intermediary conflicts of interest. Full disclosure of actual or potential conflicts is the most common and reasonable regulatory response. Empirical evidence confirms that clients do not always adequately comprehend or properly assess the effects of intermediary conflict disclosures. However, regulatory options such as prohibiting the selling of products when a conflict exists are not always feasible, practical or beneficial to potential clients.[191]

(ii) Intermediary Duty of Care

The mandated study on financial intermediary duties of care and standards reflects the longstanding debate in the US on the differences in the applicable laws and regulations applying to investment advisors and broker dealers. Financial advisors are regulated under the Investment Advisers Act of 1940, while brokerage firms are regulated under the Securities Act of 1934 and the rules of the Financial Industry Regulation Authority (FINRA), a self-regulatory authority. Brokers are able to exempt themselves from the investor adviser regulation on the basis that the advice provided is “solely incidental” to brokerage services.[192]

The duties of brokers and advisers were vigorously debated in Congress and at the US Treasury Department during the policy reform processes. While the initial draft legislation by the Senate Banking Committee removed the broker-dealer exemption from the Investment Advisers Act, Congress was unable to reach consensus and the exemption was not removed in the Act signed into law.

The SEC was concerned by the differential regulatory approach to the two intermediary groups.[193] It argued during the reform review period that all intermediaries providing financial advice should be subject to equivalent regulation and every financial professional should be subject to a uniform standard of conduct.[194] It suggested the demarcation between the functions of the two groups of intermediaries is blurred and clients fail to understand the differences between the services provided.[195] The SEC sought public feedback on 14 outlined issues, including on (i) the potential impact upon retail customers that could result from potential changes in the regulatory requitement or legal standards of care, and (ii) the effectiveness of the enforcement of the intermediary standards of care. The large number of comments received reflected the interest and controversy surrounding this area of law.[196] In January of this year, the SEC completed its mandated study concerning the obligations of brokers, dealers and investment advisers and reported to Congress.[197] The Report recommends establishing a uniform fiduciary standard for the provision of investment advice to retail customers. That is, the standard that currently applies to investment advisors would apply to broker-dealers when they provide retail advice.[198]

The debates around possible harmonisation of intermediary duties and standards of care are linked to the nature and scope of the fiduciary obligations. All investment advisers in the US are deemed to be in a fiduciary relationship with their clients and as such, owe duties of loyalty and care.[199] The courts have consistently indicated that the fiduciary standard requires advisers to act continuously in their clients “best interest”.[200] The adviser recommendations must be suitable to a client’s circumstances. While advisers ‘may benefit from a transaction with or by a client ... the transaction must be fully disclosed.’[201] By contrast, the fiduciary obligations that apply to broker-dealers are less clear.[202] Laby suggests there is general consensus that a broker with discretionary trading authority over a customer account is subject to fiduciary obligations, whereas a broker without discretionary power is not a fiduciary. However, he concedes that this general rule is subject to numerous exceptions, resulting in general confusion in this area of law.[203]

The specific client outcomes resulting from the fiduciary obligations applying to the two intermediary groups are difficult to define or explain because of a dearth of case law on broker dealer duties.[204] Laby provides the example of the sale of securities to a client from the firms’ own account. He indicates that a broker dealer can do this, however, an investment adviser cannot because of the potential conflict of interest.[205] He concludes that ‘advice is an essential ingredient of a broker’s financial services, rendering the solely incidental exclusion no longer applicable and justifying a fiduciary duty for brokers providing advice.’[206]

Langevoort agrees that the differential regulatory regimes applying to advisers and brokers are becoming untenable.[207] He warns there are no easy or comfortable solutions. The establishment of a general fiduciary duty for broker-dealers may not improve the current position because fiduciary obligations are by their very nature open needed.[208] He suggests the SEC need to provide ‘more textured rules that apply to both brokers and advisers on each of the crucial aspects of the advisory relationship.’[209]

We endorse Langevoort’s recommendations. The issue of harmonisation of duties of care across advisers is only a first step. Arguably, the more difficult and significant policy issue concerns the appropriate nature and scope of the intermediary duties on a day-to-day basis. It is not easy to establish intermediary duty of care standards that achieve an appropriate balance between financial intermediaries and clients. Determining what is in a client’s best interest at a particular time and on an ongoing basis can be difficult. Intermediaries, their advisors and clients need policy guidance that is as clear as possible on expected behaviour in circumstances that fall within the large “grey or uncertain” areas. In practice, some clients, whether sophisticated or otherwise, are eager to take on risk during boom times but are quick to pass the blame to an intermediary when things go wrong. Most parties would concur that client compensation is justified when product or advisory disclosure is fraudulent or blatantly misleading. However, what should a fiduciary standard or a best interest duty require from an broker dealer or a financial advisory intermediary when a client actively seeks riskier products such as margin loans or derivative products during the good times? To what extent are most clients able to theoretically and empirically understand notions of risk, reward and lifestyle flexibility? And should an intermediary determine the appropriateness of the product or advice based primarily on the ability of the client to absorb the risk? These are complex issues that policy makers, scholars, lawyers, financial advisors and investors continue to grapple with in all jurisdictions. The protection of investors and consumers is generally a paternalistic endeavour.[210] Ultimately, policy makers need to carefully consider the extent to which investors and consumers should be accountable for their own interests, actions and decisions.

(iii) Direct Investor Provisions

The establishment of an Investor Advisory Committee, an Office of the Investor Advocate, and a retail investor Ombudsman are positive novel developments that other jurisdictions should note. The credibility of the SEC depends to a large extent on its actual and perceived ability to protect investors from exploitation. The cost of these reforms is likely to be low while the potential investor benefits may be significant. Institutional investors tend to have effective representative bodies with established access and relationships at all political and regulatory levels, whereas retail investors often lack sufficient resources, administrative structures, and political and regulatory access to gain an effective voice.[211]

(iv) Short Selling Provisions

The short selling reforms are balanced and in line with global regulatory trends. Market participants typically argue that short selling enhances market efficiency. However, these claims are open to question when the trading is not disclosed or subject to any supervisory oversight.[212] The provisions do not prohibit or significantly restrict short selling activity. Instead, they seek to improve market transparency by requiring disclosure of short positions on a delayed basis, and to enhance market efficiency by banning trading that is not driven by economic fundamentals.

H Regulatory Performance

To operate effectively, the Act requires proactive, well-informed and coordinated intervention by the regulators. The success of the reforms therefore depends to a large extent on the competency, integrity and forcefulness of the individual regulators and their ability and willingness to supervise the finance industry on an integrated basis. However, the important issues around regulatory capture, competition for regulatory turf, and the lack of action by regulators to developments prior to the GFC were not fully debated or resolved during the legislative review processes.[213]

There are significant risks associated with the inchoate legislative approach and the number and extent of the required studies, reports and rules. The Act requires 533 rules and 93 Congressional reports to be written, and 60 studies to be completed.[214] Further, there are multiple stages required before the final rules are established, placing a heavy burden on the regulators.[215] As a result of inadequate funding, the SEC is reallocating its existing resources to satisfy the requirements under the Act, which threatens the reach and efficacy of its front line functions such as enforcement.[216] The regulators, particularly the SEC and the CFPB, are entrusted with extensive discretionary powers. The SEC must write 205 of the mandated rules and the CFPB is required to write a further 70, leaving the door open to regulatory capture by the very financial institutions that these bodies are supposed to supervise.[217]

Regulatory capture is a major issue in the US, as in many other countries. The financial services industry ‘has been the single largest contributor to congressional campaigns since 1990’.[218] One study indicates that the largest six banks and their industry bodies spent nearly $US600 million lobbying Congress on the proposed reforms.[219] Even the institutions that were bailed out using taxpayer funds paid significant sums to lobbyists.[220] Volcker highlights the political difficulties the regulators face. He suggests the response to warnings of destabilising developments in an institution or a market when things are going well will generally be we “know more about banking and finance than you do, get out of my hair, if you don’t get out of my hair I’m going to write to my congressman.”[221]

There is little doubt that the world has changed after the GFC. However, the extent to which recent events have altered the cultures and mindsets of the regulators in the US (and elsewhere) is not yet clear. Posner argues that prior to the GFC ‘the regulators of financial intermediaries were asleep at the switch’.[222] Volcker suggests there was ‘a certain neglect of supervisory responsibilities, certainly not confined to the Federal Reserve, but including the Federal Reserve.’[223] It is easy in hindsight to argue that the regulators should have responded differently. It is more important to understand why the regulators acted the way they did, and what changes in approach are required for the reforms to succeed. The regulatory responses to developments in the home mortgage markets leading up to the GFC suggest that the US regulators need to radically change the framework used to assess the net societal effects of the financial policy they administer.

In 1994 Congress passed the HOEPA prohibiting identified abusive practices. In addition, the Congress granted the Fed the power to prohibit other unfair, deceptive or abusive practices that it became aware of.[224] However, despite the continuing evidence of abusive home credit practices,[225] from 2000 to 2007 the Fed emphasised educational campaigns to improve consumers’ financial literacy and initiated only minor regulatory changes.[226] This approach was consistent with the well established global patterns of increasing deregulation and a strong reliance on markets - a fundamental belief in the ability of markets to deal with themselves, a view that regulatory interference in markets should be kept to a minimum, an emphasis on efficiency or economic factors, and a belief that consumers should act rationally and look after their own interests. The actions of the Fed were also consistent with the long-standing policy in the US to encourage people to own their own homes. Based on these worldviews, the Governors saw the growth in the subprime market as a natural and positive development that was allowing millions of people to own their own homes. They were therefore reluctant to interfere, and even though they acknowledged that abuses were occurring, they determined that the greater economic good or the net societal benefit was served by allowing the lending to continue.[227] As late as May 2007, Chairman Bernanke indicated that

we believe that the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system ...

Credit market innovations have expanded opportunities for many households. Markets can overshoot, but ultimately, market forces also work to rein in excesses. For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit’[228]
It wasn’t until 2008 that the Fed significantly strengthened the level of protection provided to consumers by amendments to the HOEPA regulation.[229] Notably, these amendments were made using its existing regulatory powers.[230]

I Conclusion

The Act represents the most substantive reform of financial regulation in the US since the 1930s. It contains some bold legislative changes. The establishment of a well-resourced single consumer protection agency may provide consumers with a regulatory body focused primarily on their interests. The reforms around trading of derivatives are important and may enhance long-term economic outcomes. Likewise the mere existence of provisions that provide for some of the losses arising from failed companies to be potentially borne by the management and directors may encourage more prudent and cautious behaviour on the part of well-advised executives and directors.

However, the communication, implementation and operational capacities of Congress and the federal regulators over the next few years will be challenged to the limit as the vast array of rules are rolled out. The extent of required rulemaking under the Act leaves all parties with significant uncertainties. The nature and scope of the reforms will only be known once the mandated studies and rulemaking are completed and the regulation is fully implemented.

Financial institutions will respond vigorously to the reform agenda. Wall Street lobbying to influence or derail the studies that have been mandated and water down the implementing regulations will be intense.[231] New financial products and innovations to minimise the potential adverse effects to institutions and to gain competitive advantages seem inevitable. Indeed, the most certain consequence of the reforms is that both regulators and financial institutions in the US are in for a very interesting and demanding few years ahead.

Timothy Geithner recently highlighted the need for the right balance between rules that protect consumers and investors and the economy, without stifling the competition and innovation that drives economic growth.[232] While few parties would disagree with this aspiration, maintaining such a balance over entire economic cycles is notoriously difficult. The temptation for us all, including policy makers, regulators, financial institutions, other capital market participants, and consumers, is to opt for short-term economic gains and to ignore longer-term risks and the adverse consequences of inaction.

The success of the reforms over the long term will depend heavily on regulatory performance.[233] As Shiller suggests, ‘the success of the Act, and the agencies created to study aspects of the market, will depend on appointing the right people ... It is a good Act but only to the extent that we make it a good Act.’[234] Given the longstanding regulatory struggle around mortgage consumer protection leading up to the GFC, and the reluctance of the federal regulators to use their existing powers and discretion to intervene to mitigate the building excesses and exposures, the key question that arises is whether the regulatory responses will be different the next time around. Have the views of the federal regulators, particularly the Fed, fundamentally changed in relation to the ability of markets to order themselves and the necessity of regulatory oversight and action?[235] Has the Fed’s conception, application and consideration of the “net societal benefit” test altered since 2007? Are the federal regulators willing to assess and determine economic policy goals using a longer-term lens that better balances the longer term costs and public interest factors with the expected short-term benefits? And are the federal regulators willing to use their previous and new powers and discretion to achieve the stated purposes of the Act? An affirmative response to these questions will require deep changes to the culture and mindset of the US regulatory agencies. Whether these changes are achievable remains the pressing question.

* Research Fellow, Faculty of Law, University of New South Wales.
∗∗ Professor of International Finance Law, Faculty of Law, University of New South Wales; Fellow, Asian Institute of International Financial Law, University of Hong Kong. The authors would like to thank the Australian Research Council for the Discovery Grant that made this research possible, and Martin North and the two anonymous referees for their valuable feedback. All responsibility rests with the authors.
[1] Barack Obama, ‘Remarks by the President on 21st Century Financial Regulatory Reform’ (Speech delivered at the White House, 17 June 2009).
[2] As such, the reform is likely to be seen by many parties as ‘post GFC reform’ or as regulation following a crisis. See, eg, Stephen Bainbridge, ‘Quack Federal Corporate Governance Round II’ (2011) 95 Minnesota Law Review 1779. Bainbridge argues that the Dodd Frank Act is a bubble act enacted in response to a major negative economic event and it represents a populist backlash against corporations and/or markets.
[3] Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates, ‘The Dodd-Frank Act: Commentary and Insights’, (Commentaries, 12 July 2010) Introductory Letter from Executive Partner.
[4] Wikipedia, Dodd–Frank Wall Street Reform and Consumer Protection Act (1 February 2011) available at
[5] The Act, § 4, 124 Stat 1376, 1390.
[6] For a summary of the mandated rules, studies and reports, see United States Chamber of Commerce, Center for Capital Market Competitiveness, Dodd-Frank Act of 2010: Summary of Rulemaking, Studies, and Congressional Reports by Title, <> NERA Economic Consulting, Dodd-Frank Rulemakings and Studies, <> .
[7] The article provides only minimal commentary on events since the Act was passed. Ongoing updates on the reform timetables and rulemaking processes are available from the regulator websites. See, eg ,The Federal Reserve Board, Dodd Frank Act Proposals at De; U.S Commodity Futures Trading Commission,, Dodd Frank Act at; U.S. Securities and Exchange Commission (SEC), Implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act at There are also many third party websites providing commentary on the reform schedules and outcomes.
[8] See United States Government Accountability Office (GAO), ‘Financial Regulation: Industry Trends Continue to Challenge the Federal Regulatory Structure’ (Report to Congressional Committees, GAO, October 2007) for a detailed outline of the Federal regulatory structure prior to the reforms.
[9] See Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (Commission Report), The Financial Crisis Inquiry Report (January 2011) xviii. The Commission Report states that we ‘do not accept the view that regulators lacked the power to protect the financial system. They had ample power in many arenas and they chose not to use it’.
[10] See, eg, Rose Kushmeider, ‘The US Federal Financial Regulatory System: Restructuring Federal Bank Regulation’ (2005) 17 (4) FDIC Banking Review. In the appendix of the paper, Kushmeider provides a summary of 24 major reviews/proposals for regulatory restructuring.
[11] GAO, ‘Financial Regulation: A Framework for Crafting and Assessing Proposals to Modernize the Outdated US Financial Regulatory System’ (Report to Congressional Addressees, GAO, 21 January 2009).
[12] Glenn Hubbard, ‘Finding the Sweet Spot for Effective Regulation’ (November 2009) 6(11) The Economists Voice, Article 4, 4. Hubbard indicates that the establishment of a systemic risk council is flawed and represents fragmentation by another name.
[13] Kushmeider, above n 10.
[14] Kushmeider, above n 10.
[15] GAO, above n 8, 15. The IMF report was undertaken as part of part of the IMF’s regular consultations of member countries under Article IC of IMF’s Articles of Agreement.
[16] GAO, above n 11.
[17] Ibid.
[18] GAO, above n 11, 9-24.
[19] The Act, § 115, 124 Stat 1376, 1403.
[20] A nonbank financial company is defined as a company that is predominantly engaged in financial activities: The Act, § 102(a)(4), 102(a)(6), 124 Stat 1376, 1391, 1392.
[21] The Act, § 171, 124 Stat 1376, 1435.
[22] The Act, §§ 121, 163, 124 Stat 1376, 1410, 1422.
[23] The Act, §§ 121. Section 121(a) provides that the Board of Governors, upon an affirmative vote of not fewer than 2/3 of the voting members of the Council then serving shall –

1. limit the ability of the company to merge with, acquire, consolidate with, or otherwise become affiliated with another company;

2. restrict the ability of the company to offer a financial product or products;

3. require the company to terminate one or more activities;

4. impose conditions on the manner in which the company conducts 1 or more activities; or

5. if the Board of Governors determines that the actions described in paragraphs 1 through 4 are inadequate to mitigate a threat to the financial stability of the United States in its recommendation, require the company to sell or otherwise transfer assets or off-balance sheet items to unaffiliated entities.
All of these actions are subject to prescribed procedural requirements.
[24] The Act, § 622, 124 Stat 1376, 1632. The Act requires the Council to complete a study on the extent to which this size affects financial stability, moral hazard, the efficiency and competitiveness of the financial firms and markets, and the cost and availability of credit and other financials services to households and businesses. This study was completed in Janaury 2011. See Financial Stability Oversight Council (FSOC) ‘Study & Recommendations Regarding Concentration Limits On Large Financial Companies’ (January 2011) available at The FSOC note at pg 8 that in ‘the near term, the concentration limit is mostly likely to restrict or otherwise affect acquisitions by four financial institutions-Bank of America Corporation, J. P. Morgan Chase & Company, Citigroup, Inc, and Wells Fargo & Company – because only these four firms, based on current estimates, appear to hold more than 5 percent of the aggregate liabilities of all financial companies subject to the concentration limit.’.
[25] The Act, § 111, 124 Stat 1376, 1392. The Council voting members include the Secretary of the Treasury, the Chairman of the Board of Governors, the Comptroller of the Currency, the Director of the Consumer Bureau, the Chairman of the Securities Exchange Commission (SEC), the Chairperson of the Corporation, the Chairperson of the Commodity Futures Trading Commission (CFTC), the Director of the Federal Housing Finance Agency, the Chairman of the National Credit Union Administration Board and an independent member. The nonvoting members include the Director of the Office of Financial Research, the Director of the Federal Insurance Office, a State insurance commissioner, a State banking supervisor and a State securities commissioner. See FSOC 2011 Annual Report available at
[26] The Act, § 112(a), 124 Stat 1376, 1394-5.
[27] The Act, § 203, 124 Stat 1376, 1450. To be placed into receivership under the Orderly Liquidation Authority, a financial company must be a ‘covered financial company’ and a written determination must be made at the initiative of the company, or at the request of the Secretary of the Treasury, the FIDC, the SEC, or in a case involving an insurance company, the Director of the Federal Insurance Office and the Board of Governors, that the company presents systemic risk.
[28] See The Act, § 203(e), 124 Stat 1376, 1454. Insurance companies cannot be placed into receivership under The Act and must be liquidated or rehabilitated under state law proceedings.
[29] The Act, § 214(c), 124 Stat 1376, 1518.
[30] The Act, § 204, 124 Stat 1376, 1454.
[31] The Act, § 214(b), 124 Stat 1376, 1518.
[32] Richard Herring, ‘The Known, the Unknown, and the Unknowable in Financial Policy: An Application to the Subprime Crisis’ (2009) 26 Yale Journal on Regulation 391, 404.
[33] David Skeel Jr, ‘The New Financial Deal: Understanding the Dodd-Frank Act And Its (Unintended) Consequences’ (Research Paper No 10-21, University of Pennsylvania Law School, Institute for Law and Economics, October 2010) 8 (published by Wiley in December 2010 as a book)
[34] John B Taylor, ‘The Dodd-Frank Financial Fiasco’, The Wall Street Journal (online), 1 July 2010 <> . See also Kenneth Scott, ‘Dodd Frank: Resolution Or Expropriation?’ (Working Paper, Stanford Law School, 25 August 2010); Jeffrey Gordon and Chris Muller, ‘Confronting Financial Crisis: Dodd-Frank’s Danger and the Case for a Systemic Emergency Insurance Fund’ (2011) 28 Yale Journal on Regulation 151. Scott argues that the Orderly Liquidation Authority procedure gives unprecedented power and discretion to an administrative official, going far beyond banking law to the point of posing serious Constitutional problems. He is concerned by the lack of due diligence and judicial overview.
[35] See Arthur Wilmarth, ‘The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-To-Fail Problem’ (2011) 89 Oregon Law Review 951, 1052.
[36] Wilmarth, above n 35, 1053-1054
[37] Notably, Mark McDermott suggests the potential harshness of the provisions may mean that the most salutary effect will be to minimize the circumstances under which it will, in fact, be used. He argues that the Act’s broad provisions and the power vested in the FIDC may work best when used as a threat to compel a private solution: Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates, above n 3, 102.
[38] Wilmarth, above n 35, 1025. Wilmarth highlights that the Federal Reserve Board’s (Fed) divestiture authority under the Bank Holding Company Act of 2006, 12 USC §§ 1841-50 (2006) has never been successfully used for a major banking organisation. He suggests that given the more stringent procedural and substantive constraints on the Fed’s authority under section 121, the prospects for a Fed ordered breakup of a systemically important financial institution seem remote at best.
[39] Section 203(b) indicates that having received a recommendation, the Secretary in consultation with the President shall appoint the FIDC as receiver of a covered financial company if he or she determines that: the financial company is in default or in danger of default; the failure of the financial company would have serious adverse effects on financial stability in the United States; no viable private sector is available to prevent the default; the effect on the claims or interests of creditors, counterparties and shareholders of the financial company and other market participants of proceedings under The Act is appropriate, given the impact of any action under The Act would have on financial stability in the United States; and an orderly liquidation would avoid or mitigate such adverse effects.
[40] The Act, § 502, 124 Stat 1376, 1580.
[41] The Act, § 619, 124 Stat 1376, 1620.
[42] The Act, § 619, 124 Stat 1376, 1620.
[43] The Act, § 619, 124 Stat 1376, 1620.
[44] The Act, § 619, 124 Stat 1376, 1620.
[45] The Act, § 619, 124 Stat 1376, 1620.
[46] FSOC, ‘Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds’ (Report, FSOC, January 2011) available at The FSOC note at pg 18 that ‘certain class of permitted activities – in particular, market-making, hedging, underwriting and other transactions on behalf of customers – often evidence outwardly similar characteristics to proprietary trading, even as they pursue different objectives’. Notably, the study concludes at pg 43 that ‘[s]upervisory review is likely to be the ultimate lynchpin in effective implementation by Agencies’.
[47] FSOC, above n 46, 3.
[48] Ian Katz and Rebecca Christie, ‘Volcker Rule Should be Robust, Financial Oversight Panel Says’ Bloomberg (online), 19 January 2011 <> .
[49] Lisa Brice, ‘2010 Financial Reform As It Relates To Hedge Funds’ (Working Paper, 19 July 2010).
[50] Brice, above n 49. See also Barry Eichengreen and Donald Mathieson, ‘Hedge Funds: What Do We Really Know?’ (Economic Issues No 19, International Monetary Fund, September 1999); GAO, ‘Hedge Funds: Regulators and Market Participants Are Taking Steps to Strengthen Market Discipline, but Continued Attention is Needed’ (Report to Congressional Requesters, GAO, January 2008). The timing of the GAO report is such that the commentary reflects only the early GFC responses.
[51] There is no limit on the amount of capital raised under Rule 506 when a company does not market its securities through general solicitation or advertising and the securities are sold only to ‘accredited investors’.
[52] The Act, § 403, 124 Stat 1376, 1571.
[53] The Act, § 404, 124 Stat 1376, 1571.
[54] The Act, § 932(a), 124 Stat 1376, 1872.
[55] The Act, § 932(a), 124 Stat 1376, 1872.
[56] The Act, § 932(a), 124 Stat 1376, 1872.
[57] The Act, § 932(a), 124 Stat 1376, 1872.
[58] The Act, § 932(a), 124 Stat 1376, 1872. The SEC has issued the following proposed rules: Nationally Recognized Statistical Ratings Organization (NRSRO) reports of internal controls; technical amendments to NRSO Rules; transparency of NRSRO ratings performance; credit ratings procedures and methodologies; certification by third parties; and establishing fines and other penalties. The rules are available at
[59] The Act, § 933(a), 124 Stat 1376, 1883.
[60] The Act, § 933(b)(2), 124 Stat 1376, 1883. On September 29 2010, the SEC revised Regulation FD to remove the exemption for entities whose primary business is the issuance of credit ratings:
[61] The Act, § 939(h), 124 Stat 1376, 1887.
[62] The Act, § 939C, 124 Stat 1376, 1888.
[63] The Act, § 939F, 124 Stat 1376, 1889. On May 10 2011, the SEC requested public input to assist the study on the rating process for structured finance products available at
[64] The Act, § 939F(d), 124 Stat 1376, 1889.
[65] Banking Act of 1933, Pub L No 73-66, 48 Stat 162 (‘Banking Act’).
[66] Banking Act § 16. However, commercial banks were permitted to purchase and sell securities on the order of and for the account of customers.
[67] Banking Act §§ 16, 21.
[68] Banking Act § 20.
[69] Banking Act § 32.
[70] Bank Holding Company Act of 1956, 12 USC §§ 1841-48 (1956).
[71] See, eg, Emilios Avgouleas, ‘The Reform of “Too-Big-To-Fail” Bank: A New Regulatory Model for the Institutional Separation of “Casino” from “Utility” Banking’ (Working Paper, University of Manchester, 14 February 2010).
[72] See, eg, Robert Litan, ‘Evaluating and Controlling the Risks of Financial Product Deregulation’ (1985) 3 Yale Journal on Regulation 1. Litan argued that while product diversification would theoretically make it possible for banks to reduce the volatility of their earnings, the freedom to diversify could increase instability in the banking system because of the danger that funds raised from insured depositors will be used to support unduly risky investments.
[73] See Gill North, ‘Structural Developments in Global Capital Markets: Promoting Efficiency or A Risky & Unstable Mathematical Playground?’ (Working Paper, UNSW, September 2011); Gill North and Ross Buckley, ‘A Financial Transaction Tax: Inefficient or Needed Systemic Reform’ (2012) 43(3) Georgetown Journal of International Law forthcoming (March/April 2012)
[74] See, eg, Stephan Schulmeister, ‘A General Financial Transaction Tax: A Short Cut of the Pros, the Cons and a Proposal’ (Working Papers No 344, Austrian Institute of Economic Research, October 2009) 5; Zsolt Darvas and Jakob von Weizsacker, ‘Financial Transaction Tax: Small is Beautiful’, (Policy Contribution No PE 429.989, Policy Department A: Economic and Scientific Policy, European Parliament, January 2010) 4.
[75] Thornton Matheson, ‘Taxing Financial Transactions: Issues and Evidence’ (Working Paper WP/11/54), International Monetary Fund, March 2011; Sony Kapoor, ‘Financial Transaction Taxes: Tools for Progressive Taxation and Improving Market Behaviour’ (Policy Brief, Re-Define, February 2010) 6. Matheson indicates that 10-20 percent of foreign exchange trading volume, 20 percent of options trading volume and 40 percent of futures trading volume in the US is algorithmic or computer based.
[76] Mary Schapiro, ‘US Equity Market Structure’ (Testimony before the Subcommittee on Securities, Insurance and Investment of the United States Senate Committee on Banking, Housing, and Urban Affairs and the United States Senate Permanent Subcommittee on Investigations, 8 December 2010).
[77] See, eg, Charles Whitehead, ‘The Volcker Rule and Evolving Financial Markets’ (2011) 1 Harvard Business Law Review 39, 69. Whitehead suggests the Volcker Rule fails to reflect important shifts in the financial markets. He argues for a narrow definition of proprietary trading and a fluid approach to implementing the Rule.
[78] Eichengreen et al, above n 50. See also Nicole Boyson, Christoff Stahel and Rene Stulz, ‘Hedge Fund Contagion and Liquidity Shocks’ (2010) 65 Journal of Finance 1789. Boyson et al link contagion in the hedge fund industry to liquidity shocks.
[79] Kapoor, above n 75, 6. Kapoor suggests that hedge funds account for 90% of the trading volume in convertible bonds, between 55-60% of the transaction in leveraged loans, almost 90% of the trading in distressed debt, and more than 60% of the trading volume in the credit default market.
[80] Eichengreen et al, above n 50.
[81] Steven L Schwarcz, ‘Private Ordering of Public Markets: The Rating Agency Paradox’ (2002) 1 University of Illinois Law Review 1, 26.
[82] Schwarcz, above n 81, 2.
[83] Yair Listokin and Benjamin Taibleson, ‘If You Misrate, Then You Lose: Improving Credit Rating Accuracy Through Incentive Compensation’ (2010) 27 Yale Journal on Regulation 91.
[84] John Hunt, ‘Credit Rating Agencies and the “Worldwide Credit Crisis”: The Limits of Reputation, the Insufficiency of Reform, And a Proposal for Improvement’ (2009) Columbia Business Law Review 109, 112.
[85] See John Coffee Jr., ‘Ratings Reform: The Good, The Bad, and The Ugly’ (Colombia Law and Economics Working Paper No 359, The Center for Law and Economic Studies – Columbia University School of Law / Law Working Paper No 145/2010, European Corporate Governance Institute, September 2010) 28.
[86] Coffee, above n 85, 53.
[87] Coffee, above n 85, 58.
[88] Coffee defines the ‘subscriber pays’ model as one that requires institutional investors to obtain their own ratings from a ratings agency not retained by the issuer or underwriter before they purchase the debt securities: Coffee, above n 85, 33.
[89] Commission Report, above n 9, 207. The Commission Report cites a statement by Jerome Fons a former managing director of Moody’s Investor Services to the FIDC on 22 April 2010 that the ‘main problem was ... that the firm became so focused, particularly the structured area, on revenues, on market share, and the ambitions of Brian Clarkson, that they willingly looked the other way, traded the firms’ reputation for short-term profits’.
[90] Commission Report, above n 9, 120.
[91] The Act, § 941(b), 124 Stat 1376, 1891.
[92] The Act, § 941(b), 124 Stat 1376, 1891. In March of this year, the regulators jointly issued proposed rules regarding risk retention by securitizers of asset-back securities available at
[93] The Act, § 942(b), 124 Stat 1376, 1897. For comprehensive analysis on loan level disclosure, see Howell Jackson, ‘Loan-Level Disclosure in Securitization Transactions: A Problem with Three Dimensions’ (Public Law Working Paper No 10-40, Harvard Law School, 27 July 2010). Jackson concludes that with a few modest refinements, loan level disclosures could revolutionize the manner in which mortgage originations in the United States are policed.
[94] The Act, § 943(1), 124 Stat 1376, 1897. The SEC has adopted new rules relating to representation and warranties in asset-based securities offerings: Release Nos 33-9175; 34-63741 (January 20, 2011) available at
[95] The Act, § 943(2), 124 Stat 1376, 1897.
[96] The Act, § 722, 124 Stat 1376, 1672.
[97] The Act, §§ 721(19), 721(21), 124 Stat 1376, 1665, 1666. In April 2011 the SEC and CFTC issued proposed swap definitions for public comment available at ://
[98] The Act, § 723, 124 Stat 1376, 1675.
[99] The Act, § 731, 124 Stat 1376, 1703.
[100] The Act, §§ 727, 729, 124 Stat 1376, 1696, 1701.
[101] The Act, § 723(a), 124 Stat 1376, 1675.
[102] The Act, § 723(a)(3), 124 Stat 1376, 1675.
[103] The Act, § 728, 124 Stat 1376, 1697. The SEC has issued a series of proposed rules for comment relating to derivatives, available from
[104] The Act, § 731, 124 Stat 1376, 1703.
[105] The Act, § 737, 124 Stat 1376, 1722.
[106] The Act, § 763(h), 124 Stat 1376, 1778.
[107] The Act, § 731, 124 Stat 1376, 1703.
[108] The Act, § 731, 124 Stat 1376, 1703.
[109] The Act, § 731, 124 Stat 1376, 1703.
[110] The Act, § 805, 124 Stat 1376, 1809. In March 2011 the SEC issued proposed rules regarding systemically important clearing agencies. In July 2011, the SEC, CFTC and the Federal Reserve Board reported to Congress on the framework for designated clearing entity risk management. The proposed rules and the Report to Congress are available at
[111] The Act, § 805(c), 124 Stat 1376, 1810.
[112] The Act, § 714, 124 Stat 1376, 1647. See Lynn Stout, ‘Derivatives and The Legal Origins of the 2008 Credit Crisis’ (2011) 1 Harvard Business Law Review 1. Stout argues that the credit crisis was primarily due to enactment of the Commodities Futures Modernization Act of 2000, which removed long established legal constraints on speculative trading in over-the-counter derivatives. She is concerned that Title VII of the Act is subject to possible exemptions that may limit its effectiveness.
[113] See, eg, Hubbard, above n 12, 1; Carlos Tavares, Short Selling and OTC Derivatives Policy Options (9 January 2011) VoxEU <> .
[114] Keith Spence, ‘Developments in Banking and Financial Law’ (2009) 29 Review of Banking & Financial Law 10.
[115] See Skeel, above n 33, 13.
[116] Schapiro, above n 76, 11.
[117] Schapiro, above n 76, 7.
[118] The Act, § 951, 124 Stat 1376, 1899. New rules under section 951 were adopted in January 2011: SEC, Shareholder Approval Of Executive Compensation And Golden Parachute Compensation Release Nos. 33-9178; 34-63768; File No. S7-31-10 (25 January 2011) available at
[119] The Act, § 953(a), 124 Stat 1376, 1903.
[120] The Act, § 953(b)(1), 124 Stat 1376, 1904..
[121] The Act, § 954, 124 Stat 1376, 1904.
[122] The Act, § 201, 124 Stat 1376, 1422. Covered financial institutions with assets of less than one billion dollars are exempted from these provisions, see The Act, § 956(f), 124 Stat 1376, 1906.
[123] On March 30 2011, the Fed issued a joint proposed rule with the OCC, FDIC, OTS, NCUA, SEC and FHFA to prohibit incentive-based compensation arrangements that encourage inappropriate risk-taking by covered financial companies, and to require the disclosure and reporting of certain incentive-based compensation information by covered financial companies. See Incentive Based Compensation Arrangements available at The final rules are still being developed.
[124] The Act, § 206(4), 124 Stat 1376, 1459.
[125] The Act, §§ 204(a)(3), 204(2), 124 Stat 1376, 1454.
[126] The Act, §§ 204(a)(3), 204(2), 124 Stat 1376, 1454.
[127] Ashley Seager and Toby Helm, ‘Brown Wins G20 Battle Against Caps on Bank Bonuses’, The Observer (online), 6 September 2009 <> .
[128] European Parliament Legislative Resolution of 7 July 2010 on the Proposal for a Directive of the European Parliament and of the Council Amending Directives 2006/48/EC and 2006/49/EC As Regards Capital Requirements for the Trading Book and for Re-Securitisations, and the Supervisory Review of Remuneration Policies, EUR. PARL. DOC. P7_TA(2010)0274 (2010). Cf. Remuneration of Directors of Listed Companies and Remuneration Policies in the Financial Services Sector, Eur. Parl. Doc. INI/2010/2009 (2010).
[129] Karen Maley, ‘The War on Bank Bonuses’, Business Spectator, 13 July 2010
[130] See eg, Jessica Holzer, ’SEC, in Split Vote, Backs Bonus Curbs on Brokers, Hedge Funds’, Wall Street Journal (online) March 3, 2011; Justin Baer and Francesco Guerrera, ‘Morgan Stanley Defers 60% of Bonuses’, Financial Times, 20 January 2011 <> .
[131] The Act, §§ 1011, 1012, 124 Stat 1376, 1964, 1965.
[132] The Act, § 1021, 124 Stat 1376, 1979.
[133] The Act, §§ 1002(5), 1002(15), 1021, 124 Stat 1376, 1956, 1957, 1979.
[134] The Act, §§ 1002(12), 1022, 124 Stat 1376, 1957.
[135] The Act, § 1024-1027, 124 Stat 1376, 1987-1995.
[136] The Act, § 1031, 124 Stat 1376, 2005.
[137] The Act, § 1013(b), 124 Stat 1376, 1968.
[138] The Act, § 1013(c), 124 Stat 1376, 1970.
[139] The Act, § 1013(d), 124 Stat 1376, 1970.
[140] The Act, § 1013(e), 124 Stat 1376, 1972.
[141] The Act, § 1411, 124 Stat 1376, 2142.
[142] The Act, § 1413, 124 Stat 1376, 2148.
[143] The Act, § 1412, 124 Stat 1376, 2146.
[144] The Act, § 1403, 124 Stat 1376, 2139.
[145] The Act, § 1414, 124 Stat 1376, 2149.
[146] The Act, §§ 1032, 1414, 1418, 1420, 124 Stat 1376, 2006, 2149, 2153, 2155.
[147] See Daniel Immergluck, ‘Private Risk, Public Risk: Public Policy, Market Development, and the Mortgage Crisis’ (2009) 36 Fordham Urban Law Journal 447 for a detailed historical outline.
[148] Immergluck, above n 147, 466. Enactment of the Alternative Mortgage Transaction Parity Act, 12 USC §§ 3801-3805 (1982), in 1982 enabled the mortgage companies that were subject to state based regulation to opt for supervision by the federal regulator.
[149] For instance, the Home Ownership and Equity Protection Act of 1994, Pub L No 103-325, 108 Stat 2190 required greater disclosure of high priced loans and prohibited some loan practices and terms.
[150] Industry opposition to new regulation governing mortgage lending was most visible at the state level. State legislators were often pressured to repeal or to weaken proposed policy by industry lobbyists arguing that regulation would reduce economic development: see Immergluck, above n 142, 471-475.
[151] U.S. Department of Treasury and US Department of Housing and Urban Development, ‘Curbing Predatory Home Mortgage Lending’ (Report, June 2000).
[152] Those opposed to stronger regulation argued that the existing lending laws were resulting in suboptimal economic outcomes. See, eg, US Office of the Comptroller of the Currency, ‘Economic Issues in Predatory Lending’ (Working Paper, 2003). The report replied on an industry funded report which found the number of subprime loans had declined in North Carolina as a result of the passing of anti-predatory lending law.
[153] For instance, in 2003 Elliot Spitzer, the Attorney General for New York State threatened to sue the OCC. See also Adam Levitin, ‘Hydraulic Regulation: Regulating Credit Markets Upstream’ (2009) 26(2) Yale Journal on Regulation 143.
[154] 550 US 1, 21 (6th Cir, 2007).
[155] The Act seeks to clarify the role of state authorities and the standards and limits of preemption. It enhances the states’ authority to enforce state and federal law against federal banks and other financial institutions in specified circumstances: The Act, §§ 1041, 1042, 124 Stat 1376, 2011, 2012. It confirms that The Act only pre-empts state law to the extent that they are ‘inconsistent’ with The Act: § 1041(a), 124 Stat 1376, 2011. It also clarifies the preemption standards and the circumstances when state law is deemed to have been pre-empted: § 1044, 124 Stat 1376, 2014. See discussion in Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates, above n 3, 183-184.
[156] On July 30, 2008, the Federal Reserve Board (the FRB) published a final rule amending Regulation Z implementing the Truth in Lending Act, 15 USC §§ 1601 et seq. (1968) (‘TILA’) and the Home Ownership and Equity Protection Act of 1994, Pub L No 103-325, 108 Stat 2190. Further, the US Congress enacted the Housing and Economic Recovery Act of 2008, 12 USC §§ 4501 et seq. (2008) on July 30, 2008, which included amendments to the TILA known as the Mortgage Disclosure Improvement Act of 2008 (MDIA). The main purpose of the TILA is to enable consumers to make informed use of credit information. The TILA requires full disclosures about credit terms and costs.
[157] See, eg, Skeel, above n 33, 13; Elizabeth Warren, ‘Unsafe At Any Rate’ (Summer 2007) 5 Democracy: A Journal of Ideas 8.
[158] Levitin, above n 153, 155.
[159] See Raymond Brescia, ‘The Cost of Inequality: Social Distance, Predatory Conduct, and the Financial Crisis’ (2010) 66 NYU Annual Survey of American Law 9; Vincent Dilorenzo, ‘The Federal Financial Consumer Protection Agency: A New Era of Protection or Mode of the Same?’ (Legal Studies Research Paper Series Paper No 10-0182, St John’s University School of Law, September 2010) 42. There are approximately 75 million owner-occupied residential properties in the US, of which 70% are mortgaged. Of the 52 million mortgaged properties, 1 in 7 (8 million), are in some stage of the foreclosure process or are at least 30 days delinquent on a mortgage payment. One in five of the mortgaged properties are in a negative equity position. The incidence of foreclosures are heavily concentrated in low-income communities and communities with predominantly black or Hispanic populations.
[160] Oren Bar-Gill & Elizabeth Warren, ‘Making Credit Safer’ (2008) 157 University of Pennsylvania Law Review 1, 100.
[161] See, eg, Levitin, above n 153, 151; Oren Bar-Gill et al, above n 160.
[162] Oren Bar-Gill et al, above n 160, 38-39. Bar-Gill and Warren cite studies by the National Training and Information Center, Freddie Mac, Fannie Mae, the Department of Housing and Urban Development, and the Wall Street Journal.
[163] Dilorenzo, above n 159, 59-60.
[164] US Department of the Treasury and US Department of Housing and Urban Development, above n 151, 72.
[165] Dilorenzo, above n 159, 60.
[166] ‘Bank of America Settles Over Mortgages’ Sydney Morning Herald (online) 5 January 2001 <> .
[167] Warren, above n 157.
[168] See, eg, Dilorenzo, above n 159.
[169] See Brescia, above n 159.
[170] The Act, § 919, 124 Stat 1376, 1837.
[171] The Act, § 919, 124 Stat 1376, 1837.
[172] See, eg, Financial Services Authority, ‘Good and Poor Practices in Key Features Documents’ (FSA, September 2007) 5; Australian Securities and Investments Commission, ‘Disclosure: Product Disclosure Statements (and other disclosure obligations)’ (Regulatory Guide No 168, ASIC, 6 September 2010).
[173] The Act, § 913, 124 Stat 1376, 1824. In January the SEC reported to Congress: SEC, Study on Investment Advisers and Broker-Dealers (January 2011)
[174] The Act, § 913(g), 124 Stat 1376, 1828. This issue was highlighted by the allegation that Goldman Sachs acted inappropriately when it recommended structured finance products to its clients while simultaneously selling on its own account: See SEC, ‘Securities and Exchange Commission v Goldman, Sachs & Co. and Fabrice Tourre, 10 Civ. 3229 (BJ)’ (Litigation Release 21489, 16 April 2010). As part of a $US550 million settlement with the SEC in relation to civil charges that it mislead clients, Goldman conceded it made a mistake by not disclosing the role of a hedge fund Paulson & Co to investors. The firm agreed to toughen oversight of mortgage securities, certain marketing material and employees who create or market such securities. Goldman will pay $US250 million to investors in the Abacus deal and the remaining US$300 million will be paid the US government: Susanne Craig and Kara Scammell, ‘Goldman Admits Mistakes in $US550m SEC Settlement’, The Australian (with the Wall Street Journal) July 16, 2010. Possible criminal prosecutions against the firm and individual employees are still proceeding.
[175] The Act, § 913(g), 124 Stat 1376, 1828.
[176] The Act, § 919B(a), 124 Stat 1376, 1838. The SEC completed this study in January 2011: SEC, Study and Recommendations on Improved Investor Access to Registration Information (January 2011)
[177] The Act, § 914, 124 Stat 1376, 1830. On January 21 2011 the SEC reported to Congress regarding the need for enhanced resources for investment adviser examinations and enforcement; available at
[178] The Act, § 918(a), 124 Stat 1376, 1837. The GAO completed this study in July 2011; available at
[179] The Act, § 919A, 124 Stat 1376, 1837.
[180] The Act, § 911, 124 Stat 1376, 1822. In practice, the Investor Advisory Committee was established by Mary Schapiro in 2009 under the Federal Advisory Committee Act, 5 USC App. (1972). The Act provides specific statutory authority for the creation of the Committee.
[181] The Act, § 915, 124 Stat 1376, 1830.
[182] The Act, § 919D, 124 Stat 1376, 1840. In June 2011 the SEC provided a letter to the Congress in lieu of a report.
[183] The Act, § 911, 124 Stat 1376, 1822.
[184] The Act, § 915, 124 Stat 1376, 1830.
[185] The Act, § 919D, 124 Stat 1376, 1840.
[186] The Act, § 922(a), 124 Stat 1376, 1841. The adopted rules to implement a whistleblower incentive and protection program were issued by the SEC in May 2001 available at
[187] The Act, § 929P(a), 124 Stat 1376, 1862.
[188] The Act, §§ 929M, 929N, 929O, 124 Stat 1376, 1861, 1862, 1862.
[189] The Act, § 929X(a), 124 Stat 1376, 1870.
[190] The Act, § 929X(b), 124 Stat 1376, 1870.
[191] See, eg, Levitin, above n 153, 148.
[192] Investment Advisers Act of 1940, 15 USC §§ 202(a)(11)(C), 80(b)-3(a)(11)(C) (2006).
[193] Mary Schapiro, the Chair of the SEC, told the Senate Committee on Banking, Housing and Urban Affairs that the services provided by brokers and advisers are virtually identical from the investor’s perspective: Mary Schapiro, ‘Enhancing Investor Protection and Regulation of Securities Markets’, (Testimony in Hearings Before the Senate Committee on Banking, Housing and Urban Affairs, 11th Congress, 26 March 2009).
[194] See, eg, Mary Schapiro, ‘SEC Oversight: Current State and Agenda’ (Testimony in Hearing Before the Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprise, United States House of Representatives Committee on Financial Services, 11th Congress, 14 July 2009); Elisse Walter, ‘Regulating Broker-Dealers and Investment Advisors: Demarcation or Harmonisation?’ (Speech delivered at the Mutual Fund Directors Forum Ninth Annual Policy Conference, Washington D.C., 5 May 2009).
[195] Schapiro, above n 194.
[196] The comments are available at
[197] SEC, ‘Study Regarding Obligations of Brokers, Dealers and Investment Advisers’ (Release No 34-62577; IA-3058; File No 4-606, SEC, 27 July 2010); SEC, ‘Study On Investment Advisers and Broker-Dealers (January 2011).
[198] SEC, above n 197, ii.
[199] SEC v Capital Gains Research Bureau Inc, [1963] USSC 204; 375 US 180, 191 (2nd Cir, 1963).
[200] See, eg, SEC v Tambone, 550 F 3d 106, 146 (1st Cir 2008).
[201] SEC v Capital Gains Research Bureau Inc, [1963] USSC 204; 375 US 180, 191 (2nd Cir, 1963).
[202] For a detailed outline of this topic, see Arthur Laby, ‘Fiduciary Obligations of Broker-Dealers And Investment Advisers’ (2010) 55 Villanova Law Review 701.
[203] Laby, ibid.
[204] Laby, above n 202, 705. Most broker dealer disputes are handled through arbitration.
[205] Laby, above n 202, 702. See also Arthur Laby, ‘Resolving Conflicts of Duty in Fiduciary Relationships’ (2005) 54 American University Law Review 75.
[206] Laby, above n 202, 742.
[207] Donald Langevoort, ‘Brokers as Fiduciaries’ (2010) 71 University of Pittsburgh Law Review 439, 441.
[208] Langevoort, above n 207, 456. See also Mercer Bullard, ‘The Fiduciary Study: A Triumph of Substance Over Form?’ (Working Paper, University of Mississippi – School of Law, 30 August 2010). Bullard highlights that the fiduciary duty is inherently principles-based. The conduct standards that apply under a fiduciary duty are revealed through case law.
[209] Langevoort, above n 207, 455.
[210] See, eg, Levitin, above n 153, 148.
[211] See Alicia Davis Evans, ‘A Requiem For The Retail Investor?’ (2009) 95 Virginia Law Review 1105.
[212] Tavares, above n 113.
[213] Levitin, above n 153, 155-161.
[214] United States Chamber of Commerce, above n 6.
[215] The rulemaking procedure generally includes the issuance of a concept release or notice of proposed rulemaking. This is followed by a proposed rule that is released for public comment. Once the final rule is issued, there is generally a phasing in period to allow industry time to prepare for compliance.
[216] Congress initially authorised annual budget increases to the SEC for the next five years, with $1.3 billion approved for 2011, stepping up to $2.25 billion in 2015: The Act, § 991, 124 Stat 1376. However, the budget deal agreed in April 2011 between the Administration and House Republicans resulted in significant cost cutting. The SEC received only a small increase in its funding for 2011 and is reallocating resources or using its existing officers to satisfy some of the requirements under the Act. The funding of the CFPB is more flexible. The director of the CFPB determines the amount reasonably necessary to carry out the authorities of the Bureau, up to a funding cap based on a percentage of the total operating expenses of the Fed: The Act, § 1017, 124 Stat 1376, 1975.
[217] See Skeel, above n 33. Skeel suggests the objectives of the Act are right on target. However, he is concerned by (1) the government partnership with the largest financial institutions and (2) ad hoc intervention by regulators rather than more predictable, rules-based response to crises.
[218] Levitin, above n 153, 161. Levitin cites Sunlight Foundation, Industry Sector Campaign Contributions, 1990-2008 (5 April 2010) <> .
[219] Kevin Conner, The Big Bank Takeover: How Too Big to Fail’s Army of Lobbyists Has Captured Washington, (11 May 2010) Institute for American’s Future <> .
[220] Paul Kile, Bailed Companies Spend Millions to Lobby Congress, (22 July 2009) Propublica Senate disclosure forms indicate that as the rule making processes are negotiated, the lobbying spend and efforts are continuing in the Congress and at the regulatory agencies.
[221] Damian Paletta, ‘Ronald Reagan’s Fed Chief Takes Aim at America’s Battered Financial System’ The Australian (with the Wall Street Journal) (online), 24 September 2010 <> . In practice, it is difficult for regulators to raise the alarm about potentially adverse developments when markets and economies are performing well. Individuals, particularly those with positions and reputations to protect, do not want to be seen to have acted to stop the money rolling in or to be shown in hindsight to have made the wrong call. As Jane Diplock, Chair of the International Organization of Securities Commissions expresses it, ‘[w]hen everybody appears to be making money, and there’s exuberance in the markets, it’s extremely difficult to be the Jeremiah saying: “Look, that’s a cliff you’re about to run over”. Nobody wants to hear that message, least of all politicians whose funds are perhaps being swollen by the very people making all this money’: Australian Securities and Investments Commission: ‘Securities and Investment Regulation: Beyond the Crisis’ (1–3 March 2010, Melbourne, Australia) available at
[222] See Richard Posner, ‘Financial Regulatory Reform: The Politics of Denial’ (2009) 6(11) The Economists’ Voice Article 1, 2. Posner argues that the two main causes of the financial crisis were incompetent monetary policy and ‘the regulators of financial intermediaries were asleep at the switch’. He suggests these problems are not cured by the legislative reforms. Posner explains the lack of discussion about regulatory failure as the presence of the politics of denial because the government’s senior economic officials were implicated in the failures.
[223] Paletta, above n 221.
[224] Federal Trade Commission Act Amendments of 1994, 15 USC § 45(n) (1994). The 1994 Amendment provided that: The Commission shall have no authority under this section or section to declare unlawful an act or practice on the grounds that such act or practice is unfair unless the act or practice causes or is likely to cause substantial injury to consumers which is not reasonably avoidable by consumers themselves and not outweighed by countervailing benefits to consumers or to competition. In determining whether an act or practice is unfair, the Commission may consider established public policies as evidence to be considered with all other evidence. Such public policy consideration may not service as a primary basis for such determination.
[225] In 2001 the Federal Reserve acknowledged increased reports of home purchase loans and re-financings which generally included one or more of the following:

1. making unaffordable loans based on the borrower’s home equity without regard to the borrower’s ability to repay the obligation;

2. inducing a borrower to refinance a loan repeatedly, even though the refinancings may not be in the borrower’s interest, and charging high points and feeds each time the loan is refinanced, which decreases the consumer’s equity in the house; and

3. engaging in fraud or deception to conceal the true nature of the loan obligation from an unsuspecting or unsophisticated borrower – for example, ‘packing’ loans with credit insurance without a consumer’s consent: Truth in Lending, 66 Fed Reg 65604 (20 December 2001).
The Fed also acknowledged evidence of targeting of vulnerable groups. The Board noted: The reports of actual cases [about predatory lending] are ... widespread enough to indicate that the problem warrants addressing. Homeowners in certain communities – frequently the elderly, minorities and women – continue to be targeted with offers of high-cost, home-secured credit with onerous loan terms. The loans, which are typically offered by nondepository institutions, carry high up-front fees and may be based solely on the equity in the consumers’ homes without regard to their ability to make the scheduled payments. When homeowners have trouble repaying the debt, they are often pressured into refinancings their loans into new unaffordable, high-fee loans that rarely provide economic benefits to the consumers. These refinancing may occur frequently. The loan balances increase primarily due to fees that are financed resulting in reductions in the consumers’ equity in their homes and, in some cases, foreclosures may occur. The loan transaction may also involve fraud and other deceptive practices.
[226] Dilorenzo, above n 159, 79.
[227] Edmund Andrews, ‘Fed and Regulators Shrugged As the Subprime Crisis Worsened’, New York Times (New York) 18 December 2007, A1.
[228] Chairman Ben Bernanke, ‘The Subprime Mortgage Market’ (Speech delivered at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Chicago, 17 May 2007).
[229] Truth in Lending, 73 Fed Reg 44522 (30 July 2008).
[230] See Posner, above n 222, 4. Posner concludes that the Federal Reserve and the other regulators had the power to avoid the monetary excesses that accelerated the housing boom and to stop questionable lending and trading decisions by financial institutions. See also Commission Report, above n 9, 187. The Commission Report Chapter 9 conclusion states that the Federal Reserve failed to recognize the cataclysmic danger posed by the housing bubble to the financial system and refused to take timely action to constrain its growth, believing that it could contain the damage from the bubble’s collapse.
[231] Damian Paletta, above n 221. Volker praises the financial reforms, but says the system remains at risk because it is subject to future ‘judgments’ of individual regulators who will be relentlessly lobbied by banks and politicians to soften the rules.
[232] Ian Katz and Rebecca Christie, ‘Volcker Rule Should be Robust, Financial Oversight Panel Says’ Bloomberg (online), 19 January 2011 <> .
[233] Richard Posner, above n 222, 4.
[234] See also Amanda White, Dodd-Frank Act Will Stand or Fall on Right People (15 September 2010) <> .
[235] See Gill North and Ross Buckley, ‘A Fundamental Re-examination of Efficiency in Capital Markets in Light of the Global Financial Crisis’ [2010] UNSWLawJl 30; (2010) 33 University of New South Wales Law Journal 714.

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