Washington, D.C. attorney Winthrop Brown has been advising banks for 25 years on business and compliance matters. He spoke with Bank Systems & Technology on Friday afternoon about the just-passed Dodd-Frank Wall Street Reform and Consumer Protection Act as it headed over to President Obama's desk for signing.
BS&T: Could the bill still be changed at this point?
Brown: There's talk of a technical corrections bill that will be needed in the course of the next several months. There's lots of speculation about it. Any bill of a technical nature, particularly one written in the middle of the night as this one was, needs a true technical corrections bill to correct typos, references and such. That is fully expected. Congressman Frank promised there would be at least one substantive issue dealt with in any technical corrections bill, it has to do with treatment of end users under the derivatives title, Title 7. There's speculation about other things that might creep into that bill, and about when it might be presented and discussed, if at all. Some people think that no one's going to touch it with a 10-foot pole until after the election.
BS&T: Based on your experience in Washington, could there be a lot of substantial changes?
Brown: In general, Congress is good about limiting technical corrections bills to technical corrections. It's easy to derail a piece of legislation if it strays from that housekeeping function. It will be interesting to see here whether it will be the housekeeping function plus the one substantive piece that Frank promised, or whether it will be the technical housekeeping things plus the end user provision plus two others. The consensus would have to be pretty broad for it to be able to proceed with any other substantive revisions.
BS&T: It seems that the bill gives regulators a tremendous amount of discretion and a lot of the bill seems very vague.
Brown: I think that's an accurate characterization. It's not so much that regulators are given authority to make regulations, it gives them the ability to shape things that will be very substantive. There's not a lot of guidance given in the mandate to write regulations. Imagine yourself an agency staff lawyer who's got to do the first draft of that regulation, you have a pretty free hand. The only challenge to a regulator at that point would be someone who's unhappy with the result challenging the regulation in court, saying it went beyond what the statute mandated.
BS&T: The Independent Community Bankers Association said today that they're planning to make a lot of changes and they're going to work with regulators to do so after the law is signed. I wonder how malleable the regulators are going to be?
Brown: I think there's a lot to be gained in interacting with the regulators and offering comments on the final regulations. It is a process that allows for changes to what's proposed. And because there's a give and take with industry and consumer groups, you get a high-quality product out of the regulators. They do a very good job considering. They have freedom under the language of the statute to take into account people's viewpoints. My guess is they're going to be pretty tough on industry, just because that's the whole spirit of the statute. They know well that Congress was upset and wanted something done.
BS&T: How do you look at this professionally? Harvey Pitt today called this the "Lawyers' and Consultants' Full Employment Act of 2010."
Brown: He also was very critical of the statute, a view I don't share. There's no question that there will be a large number of rules proposed, comments submitted, meetings held, and analysis produced based on what's going to happen between now and two years from now under the statute. Lawyers will be part of that, and they will be paid as a result. In that sense, it's important to lawyers and practitioners. In another sense, this idea is exaggerated. The real legal work will come about after the rules are issued and banks, investment banks and their affiliates once again start to try enter into business transactions, new lines of business and so forth, and they'll need to understand what they can and can't do, which is the traditional role of the lawyer. In that sense, lawyers will be very busy. Most of the work with regulators will be with the trade associations and their in-house lawyers.
During the legislative process, most of us sat back and watched what happened, unless we had a trade association client. We spent a lot of nonchargeable time trying to follow the statute and thinking about what the effect might be on our clients.
BS&T: What do you think are going to be the biggest changes for banks — the living will requirement, higher FDIC fees, lower interchange, the consumer protection bureau?
Brown: You can divide this into categories. There are provisions that will be costly and perhaps require more reporting, but that don't prevent banks from doing anything. You can put interchange fees, most of the consumer protection provisions, and mortgage reform provisions in that bucket. The new capital and liquidity requirements also will probably end up just being expensive, a huge drag on profitability, but not change behavior all that much.
In another category, there are provisions that affect relationships with regulators — the merger of the OTS and OCC, the creation of an oversight council. It will be interesting to see the role the oversight council plays in the back and forth most institutions have with their regulators. Under current rules, if a big bank wants to do something — make an acquisition, try some unusual expansion, it works with the Fed and eventually receives an informal blessing of some kind. Two years from now, will it need to work with the oversight council as well? Suppose the oversight council has a big staff and there are issues about systemic risk or concentration associated with the acquisition?
BS&T: With some of these provisions, I feel like it's still the same cast of characters in Washington.
BS&T: And the big banks have all had hundreds of regulatory staff members in their banks every day, throughout the crisis.
Brown: Permanent examiners. And you can't take them to lunch.
BS&T: You can hire them, though.
Brown: Yes, sometimes the banks do hire them.
BS&T: So how much change can we really expect? The regulators are already a big force in banks and the personnel is not changing much, except for the people they will hire for the Consumer Protection Bureau.
Brown: It is the same and there's going to be more made of the changes than in fact will occur. It's more of a spirit and attitude that will change with the legislation among the existing cast of characters, as you say, at the regulators. Many of the Consumer Protection Bureau staffers will be drawn from the consumer protection divisions of the Fed, the OCC, the OTS. They're going to move into a new building, they'll be the people who know those rules the best and all those consumer statutes, the Truth in Lending Act, and so forth. They'll have more prominence than when they were within those other agencies and they'll be under a mandate to protect the American consumer, so they'll be more energetic than they were, but it will probably be the same people.
BS&T: I spoke to some bankers a month ago about the new legislation and the consumer protection bureau seemed to be the thing they were most concerned about because they felt like it will have a lot of authority to write its own rules, it will have a big budget, and it will have carte blanch to do whatever it wants.
Brown: That's probably fair, although I would put the consumer protection bureau in that category of, it will make my life more difficult and expensive, but it's not really going to change what I can and can't do.
There are provisions that will affect banks more strongly. The prohibition of hedge fund investments and of proprietary trading in the Volcker rule will actually prevent institutions from doing certain things they were permitted to do under current law. There's a risk retention requirement in one of the titles on securitization that will affect the way institutions do business. Those are the provisions we'll be spending a lot of time on, trying to craft ways to live with those rules and still continue to do as much of the previous business as possible.
BS&T: The regulators don't seem to understand what firms like Goldman Sachs, which paid its parking ticket to the SEC today, are doing with their structured products. Is there any reason to believe that that will change?
Brown: There is a gap between what the investment banks do, the products they invent and sell, and the level of knowledge and sophistication of regulators, in particular the SEC. But on the other hand, the SEC has been living with the world of securitization and its more sophisticated manifestations in CDOs and CLOs for a long time and has the wherewithal to figure out what the investment bankers are doing. It has the tools to examine CDO marketing and offering documents. The SEC was able in this suit to allege violations of the 1933 Act for failure to disclose important facts. The investment bankers are quite indignant. They say, of course we bet against this product. Of course we consulted Mr. Paulson, how can you create a synthetic CDO without talking the guy who's going to take the other side of the bet? They look at the SEC accusation and say, what do you mean we didn't disclose that we talked to the people on the other side. Everybody knows that that's what you do when you do a CDO of this kind. Those investors knew what a synthetic CDO was and knew exactly what was going on.
BS&T: I have a different view of that.
Brown: Sometime we should have a debate because there are two sides to it.
BS&T: I guess time will tell if the new law will have much of an effect on products like Abacus.
Brown: Yes. The effect will be more in the fact that the regulators will be attentive where they weren't before, or more strict where they weren't before.
BS&T:If the Fed becomes stricter, could a company like Goldman simply give up its bank holding company charter?
Brown: There's a provision in the statute that makes it more difficult to leave the bank holding company status. They were very concerned about that.
BS&T: Do you think the Fed's role will change dramatically?
Brown: Dramatically may be too strong a word, but I think it will change significantly because of the oversight responsibilities it has and its new jurisdiction over nonbank financial companies. That's a big responsibility. If I were Bernanke, I would be thinking about how to organize the staff and the agency to take on the role of being the first line of defense on systemic risk and looking at players in the marketplace that are not just the guys you're used to, the bank holding companies. I think that's going to be a big undertaking for them.
BS&T: They've got to start watching the big insurance companies…
Brown: Yes, hedge funds, insurance companies, they have to worry much more than they have in the past about mortgage lenders. It's a tough mandate because they're going to find it's amorphous at the edges — how do you determine who's systemically important? Congress didn't give a lot of guidance on that.
BS&T: Final question, do you have any specific recommendations for banks as they start to figure out what to do about this law?
Brown: The first recommendation I have is that I think they should be very involved in the regulatory process. I live and work inside the Beltway, so I may sound like a Pollyanna on this, but I believe because I've seen it happen that well-meaning, thoughtful participants can have an influence on the outcome of the regulatory process. I have a high regard for the quality of most of the staff on these agencies, I think they're good and smart people and they will listen to you, they will take your views into account. A lot of bankers are cynical about the Washington process and might not want to do it for that reason, but I think they should.
The other thing is to continue the emphasis that's grown in recent years on compliance and risk management and give it high level executive support, which is the part that's typically missing. If there's a problem, if you scratch the surface, you often find that the senior people didn't think risk management was all that important, it was just expensive.