On July 21, 2010 President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank” or the “Act”) into law. Dodd-Frank is seen as the greatest transformation in the regulation of the financial services industry since the Glass-Steagall Act of 1933, enacted in response to the Great Depression. Spanning almost 9,000 pages of rules and regulations, Dodd-Frank is an enormous, complex piece of legislation. Among its many objectives, Dodd-Frank aims to: (1) increase consumer financial protection; (2) reduce the systemic risk created by large financial institutions; (3) ensure orderly liquidation and resolution planning; (4) place strict requirements on the use of derivative products; and (5) reduce proprietary trading within banks.
In meeting these diverse and aggressive objectives, Dodd-Frank requires regulatory agencies to draft and implement approximately 400 new rule requirements. Although dozens of agencies are playing a role in the reform, explicit references to rule making requirements in the Act fell heavily upon two agencies: the Securities Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). Just over two years since the legislation has been enacted about 65% of the rules have been proposed or finalized. However, recent court decisions indicate that agency rulemaking is just the beginning of the process and the laws that will regulate the financial services industry in this new era are far from settled.
On September 28, 2012, Judge Robert Wilkins of the United States District Court for The District of Columbia struck down the CFTC’s rule on position limits. Position limits are essentially caps on the number of derivative contracts a trader can own during a specified period of time. The challenges that the CFTC faces are not uncommon. The Fordham Corporate Law Forum has previously covered the renewed momentum and resources of Dodd-Frank rule making agencies. In light of their emboldened powers, these agencies have greatly picked up the pace of rulemaking. If court challenges continue, however, agencies will be hard pressed to keep pace with their aggressive rulemaking schedules while re-writing and re-submitting previously proposed rules. For instance, last year the United States Court of Appeals for the District of Columbia found that the SEC did not perform adequate analysis regarding the impact of its proposed rule on shareholder board voting rights and therefore acted “arbitrarily and capriciously” in drafting the rule. In general, judicial scrutiny has centered on the promulgating agencies’ alleged failure to demonstrate that their rules have been crafted as congress intended. It also focuses on the purported failure to provide empirical evidence that the rules are both necessary and sufficient to further the objectives of the legislation.
Eugene Scalia (son of Justice Antonin Scalia), who frequently represents firms in the financial services industry that challenge these rules, notes that the SEC has lost all six cases in the Washington, D.C. federal court of appeals since the mid-2000s. Scalia puts forth several explanations for the poor track record of the agencies, including: a failure to meet heightened requirements for justifying new rules in light of their economic impact, a failure to explain the logic and rationale behind the new rules, and a failure to meet the procedural requirements of the Administrative Procedure Act. Given the breadth of rule writing still ahead, rule-making agencies face a rigorous challenge in putting forth more in-depth analysis and research into each new rule. Nevertheless it is a challenge courts do not appear to be wavering on.
In any event, contention surrounding regulation of the financial services industry is somewhat expected. To put things into perspective, the Glass-Steagall Act was also enacted on the heels of a catastrophic financial crisis where politicians were under pressure to quell public outcry and fear. Much of Glass-Steagall centered on prohibiting commercial banks, that held deposits of individuals, from engaging in what was perceived as more risky trading and underwriting activity. Following a 1934 study that cast doubt around some of the premises of Glass-Steagall, Senator Glass (who initially proposed the Act), put forth an amendment to undo parts of the Act. Over the next sixty-five years Glass-Steagall slowly eroded further as regulators and legislators passed numerous laws limiting its reach and scope. The main components of the Act were finally repealed in 1999 with the passing of the Gramm-Leach-Billey Act.
Indeed, because Dodd-Frank and Glass-Steagall share striking similarities at their inception, questions arise as to whether they will share a similar defeat. Are the early legal challenges that Dodd-Frank has faced emblematic of eventual legislative and regulatory reversal to come? Will Dodd-Frank be an example of a legislative knee-jerk reaction that undergoes half a century of unwinding? In the alternate, will Dodd-Frank be a lasting and much needed tightening of an industry that is predisposed to dangerous and aggressive risk taking?
Perhaps the current challenges to Dodd-Frank in connection with the legacy of Glass-Steagall suggest a more appropriate path for financial regulation. Modern finance is incredibly complex. The financial instruments available today and the pace of development is the byproduct of hundreds of years of financial innovation. We cannot expect reform to come overnight. Rather than responding to crisis with threats or promises (depending on how you view them) of immediate and drastic changes to the face of financial services that are followed by arbitrary and baseless limits and requirements, regulators should take a more steady and prudent approach to the review of the needs of financial investors, consumers and institutions. Regulation cannot effectively help any of these parties while subsequently alienating another. Reform requires more thinking and less grandstanding, it should be characterized by thorough research and well evidenced and articulated rules with explicit intent. The current uncertainty surrounding the regulatory environment has failed to aid consumers, investors or institutions and, as evidenced by their failed attempts at rulemaking, has left agencies without a clear mandate and just enough rope to hang themselves and the economy.