Financial Markets in Crisis: Administration Releases “White Paper” on Reforming the Financial Regulatory System

June 17, 2009

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets.

We are providing updates on key regulatory and legislative issues, as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times.

This update focuses on the Obama Administration’s release of a White Paper detailing its proposal to reform the financial regulatory system.  This alert provides a summary of the Administration’s Proposal, reactions from various industry groups, and commentary on various topics.

Overview and Procedural Posture

Today, the Administration announced a proposal to reform the financial regulatory system.  President Obama called it “a sweeping overhaul . . . , a transformation on a scale not seen since the reforms that followed the Great Depression.”  And it is.

We surveyed reactions to the proposal from different industry groups and found cautious support mixed with reservations — some specific, some general.  The most frequent concerns are with the new Consumer Financial Protection Agency, which the U.S. Chamber of Commerce characterizes as a “stand alone . . . agency that cannibalizes regulatory expertise and [adds] yet another regulatory layer.”

Reaction on Capitol Hill was somewhat muted, though both House Financial Services Chairman Barney Frank and Senate Banking Committee Chairman Christopher Dodd expressed strong support for the proposal (and, in particular, the Consumer Financial Protection Agency).

In the coming weeks, it is expected that the Administration will send actual legislative language to Congress.  Chairman Frank has indicated that, once he has received language, he will produce a bill and mark it up as quickly as possible — possibly before the August recess but more likely in September.  Chairman Dodd is working on a slightly less aggressive timeline and has stated that he will turn from health care reform to financial services reform in the Fall.

Summary of and Commentary on the White Paper

I.  Supervision and Regulation of Financial Firms

The Administration has indicated that the financial crisis was caused in significant part by “inadequate and inconsistent” regulation of the largest financial firms, which allowed those firms to become dependent on short-term funding, set weak risk-management standards, and maintain inadequate levels of capital.

A. Financial Services Oversight Council

Following a clear shift in Congress toward a council approach to systemic oversight, the Obama Administration has proposed the creation of a Financial Services Oversight Council (FSOC or the Council) which would be headed by Treasury.  The Council would be composed of the Secretary of the Treasury, the Chairman of the Fed, the National Bank Supervisor Director, the Consumer Financial Protection Agency Director, the FHFA Director, and the Chairmen of the SEC, CFTC, and the FDIC.  The Council would have a full-time staff located at the Treasury.

The Council would be charged with facilitating the sharing of information, identifying systemic risks, and advising the Federal Reserve about firms that could pose substantial risks.  The Council also would help resolve conflicts between regulatory bodies.  The Council would have the authority to require reports from any U.S. financial firm solely to determine the level of risk the firm poses to the economy.

B. Federal Reserve Authority as Systemic Risk Regulator

The Administration identified inconsistent regulation of financial holding companies and other large firms as a fundamental flaw underpinning the financial crisis.  Its Proposal would consolidate financial holding company regulation and supervision in the Federal Reserve and give it authority over a greatly enlarged class of financial holding companies including all systemically significant institutions as determined by the Fed.  Specifically, the Administration states that “[a]ll large, interconnected firms whose failure could threaten the stability of the system should be subject to consolidated supervision by the Federal Reserve, regardless of whether they own an insured depository institution.”

The Fed would use criteria such as the size, leverage, and interconnectedness of a firm to determine what firms it would regulate as Tier 1 Financial Holding Companies (FHCs).  While it would be advised by the Financial Services Oversight Council on decisions to designate firms as Tier 1 FHCs, the decision would be the Fed’s.  Furthermore, the Fed would be able to examine any large U.S. firm that meets certain size thresholds to determine whether it should be regulated as a Tier 1 FHC.

The Obama plan calls for the “largest, most interconnected, and highly leveraged” firms to be subject to increased prudential regulation by the Fed and increased capital, liquidity, and risk management standards.  Those standards would be higher than the standards imposed on average firms to address the greater risk that those firms may pose to the economy.  This consolidated supervision would extend to the parent and all of its subsidiaries; depository institution subsidiaries would continue to be regulated by their functional or bank regulator.  The plan also would remove the constraints imposed on the Fed by the Gramm-Leach-Bliley Act that prevent the Fed from acquiring reports from depository institutions or other “functionally regulated” companies (e.g., insurance companies) or from imposing prudential standards on them. The plan would require the Fed to propose recommendations to better align its structure to match its new responsibilities by October 1, 2009.


While the FSOC will identify emerging systemic risks and advise, make recommendations to and consult with the Federal Reserve concerning such risks and related entities, it is the Federal Reserve that will become the preeminent financial regulator over systemic entities and the financial system as a whole.  In this regard, the Federal Reserve will be empowered to supervise all firms that could pose a threat to financial stability — regardless of whether the firm is part of a banking organization or owns a bank or other depository institution.

Essentially, the historic justification and basis for bank — or bank holding company — like safety and soundness (or “prudential”) supervision and regulation is eliminated.  That is, a government benefit such as deposit insurance or access to the discount window or payment system would no longer be the basis for the extension of this type of regulation to an entity.  Instead, even if a financial firm or organization does not directly or indirectly participate in any such government benefit program, it may find that the Fed has determined that the nature of its operations (e.g., risk of failure could “threaten financial stability”) place it in this new Tier 1 FHC class and subject it to bank-like supervision and regulation.

In connection with its determination, the Federal Reserve may consider any factor it deems relevant in addition to the statutory designated factors.  Even then, it will also have the discretion not to apply these factors to an individual firm.  These designated factors include:

  • the impact the firm’s failure would have on the financial system and the economy;
  • the firm’s combination of size, leverage (including off-balance sheet exposures), and degree of reliance on short-term funding; and
  • the firm’s criticality as a source of credit for households, businesses, and state and local governments and as a source of liquidity for the financial system.

The activities of the Tier 1 FHC would be limited to those permitted for financial holding companies under the Bank Holding Company Act of 1956 and the Federal Reserve’s implementing Regulation Y.  Thus, “commercial” companies would be legally barred from entering into and succeeding in financial lines of business on a scale that could result in their becoming a systemic risk firm.

The proposal also raises other concerns.  The Proposal does not offer a consistent definition of “systemically important.”  Nor does it explain whether the affiliates and associated persons are deemed to be systemically important, as well.  The Proposal also does not address how to prevent companies from remaining just below Tier 1 levels to avoid the heightened regulation except to say that the Fed should be able to have “flexibility” in determining which companies should be designated Tier 1 FHCs.

Business groups appear to be split on the council approach, but there is likely to be considerable concern over identifying “too big to fail” institutions, as the Proposal would do, due to the notion that such designations could confer implied government backing.

C. Capital and Prudential Standards; Executive Compensation and Accounting Standards

To ensure that banks have the capital on hand to weather another crisis, the Proposal calls for a Treasury working group to issue a report on bank and bank holding companies’ (including new Tier 1 FHC’s) capital requirements by December 31, 2009, and a report on supervision of those institutions by October 1, 2009.

The working group would be asked to study, among other things, proposals to increase capital requirements on “investments and exposures that pose high levels of risk under stressed market conditions.”  Such investments and exposures could include mortgage backed securities and OTC derivatives that are not centrally cleared.

Recognizing that many compensation structures currently reward short term gain without regard for long term risks, the Proposal recommends that federal regulators issue executive compensation standards that align incentives to maximize shareholder value and promote the safety and soundness of financial firms and other FHCs.

The Administration has asked the SEC, IASB, and FASB to review certain accounting standards and, in particular, to examine fair value accounting rules and consider changes that would increase transparency for investors.


Executive Compensation: The White Paper’s approach to compensation practices is consistent with the Treasury Department’s statement last week on executive compensation practices at all public companies.[1]  However, the tone of the White Paper is a bit more strident in linking compensation practices at financial services firms, which “rewarded short-term profits at the expense of long-term value,” to the current financial crisis.  In addition to its position that federal regulators (a) issue standards on compensation practices to ensure that they are aligned with shareholder interests and promote long-term value creation, and that do not threaten the stability of a firm and (b) support the passage of say-on-pay legislation and enhanced compensation committee independence standards, the White Paper contains specific suggestions applicable to financial services firms.

First, the White Paper suggests that the Treasury Department, Federal Reserve, SEC and federal banking regulators lay out standards on compensation at financial services firms as part of the overall supervisory process, and that the President’s Working Group on Financial Markets and the Financial Services Oversight Council perform their own risk assessment review vis-a-vis current compensation practices, “with a focus on identifying whether new trends might be creating risks that would otherwise go unseen.”  Second, the White Paper suggests that the compensation of those involved in loan securitization (brokers, originators, sponsors and underwriters) should be linked to the long-term performance of the loans, and not only to the creation of those products.  The White Paper further provides that the SEC should be empowered to examine and ban any form of compensation that encourages broker-dealers and investment advisors to sell products to investors that are not in the investor’s best interest.  Third, the White Paper urges other countries to create their own sets of compensation guidelines in line with those announced by the Treasury Department.

Last week, in anticipation of today’s announcement, the Securities Industry and Financial Markets Association (SIFMA) issued guidelines containing four principles that financial services firms should use to ensure that compensation is tied to long-term performance and risk management.  In addition to outlining these four principles, the guidelines make clear that boards of directors and compensation committees are in a better position to perform this analysis than federal regulators.  The SIFMA pledged to work with governments globally to craft compensation practices that achieve these principles, but emphasized that any regulatory oversight should not stifle economic growth, nor interfere with firms’ hiring and retention of talented professionals.

D. Creation of a National Bank Supervisor and Elimination of the Federal Thrift Charter

The Administration proposes the creation of a National Bank Supervisor (NBS) to conduct prudential supervision and regulation of all federally chartered depository institutions.  The NBS will be an agency with separate status within Treasury.  This agency would assume the authority and prudential responsibilities of the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS), which would be eliminated.  The OCC currently charters and supervises nationally chartered banks, while the OTS has responsibility for federally chartered thrifts and thrift holding companies.  Under the Proposal, the Federal Reserve and FDIC would maintain their current responsibilities over state-chartered banks, and the National Credit Union Administration would retain authority over credit unions.  The creation of the NBS would be accompanied by the elimination of the federal thrift charter.  In addition, the Proposal seeks to eliminate restrictions on interstate branching by national and state banks.

Under the Proposal, all companies that control an insured depository institution will be subject to supervision and regulation by the Federal Reserve.  These companies will also be subject to the Bank Holding Company Act, which restricts engagement in non-banking activity.  Industrial Loan Companies (ILCs), which are currently regulated by the OTS and not subject to the Bank Holding Company Act, will be given five years to conform to the restrictions regarding the separation of banking and commerce under the Bank Holding Company Act.  All holding companies of ILCs, thrifts, credit card banks, trust companies, and “nonbank banks” will become Bank Holding Companies.


While the combination of the OTS and the OCC into a single banking agency is not surprising, the Proposal’s elimination of the numerous limited bank charters (such as credit card banks) which have been established by retailers and others without objection or particular problems for the last 20 years is unexpected.  These limited-purpose institutions have not contributed to the financial crisis or been a source of regulatory problems.  Likewise, the requirement that existing grandfathered “unitary” S&L holding companies that engage in nonfinancial activities must become bank holding companies is the most extreme option for addressing the regulation of these companies following the OTS-OCC combination.

These changes reflect the ascendancy of the Fed’s longtime view that “banking” and “commerce” should not be conducted in one organization — a view held most fervently by former Fed Chairman Paul Volcker, who is an Obama adviser.

E.  Eliminate SEC Programs for Consolidated Supervision

The Administration would eliminate the SEC’s Supervised Investment Bank Holding Company program (much as the SEC ended its Consolidated Supervised Entity Program after the Lehman Brothers and Bear Stearns collapses).  The Federal Reserve would be the consolidated supervisor of investment banking firms.

F. Registration of Hedge Fund Advisors

The White Paper proposes significantly strengthening regulation over private pools of capital, including hedge funds, private equity funds and venture capital funds.  A key objective of the proposed regulatory changes are to provide regulators with comprehensive data on private funds in order to assess the systemic implications of their market activities. The proposed regulations would also seek to fill a perceived gap in protections for investors in these funds.

  • Registration of Advisers:  Specifically, the White Paper proposes that all advisers to private pools of capital whose assets under management exceed a “modest” threshold be required to register with the SEC under the Investment Advisers Act of 1940.  Registration would subject advisers to recordkeeping, reporting and disclosure requirements under the Advisers Act.  In contrast to proposed legislation in Congress such as the Hedge Fund Transparency Act, S 344, however, the funds themselves would not be required to register.
  • Proposed Regulatory Requirements:  The White Paper also proposes to impose additional regulatory requirements on funds advised by registered advisers, including recordkeeping requirements; enhanced requirements for disclosure to investors, creditors and counterparties; regulatory reporting requirements; and regular and periodic SEC examinations to confirm regulatory compliance.
  • Large Private Funds Regulated as Tier 1 FHCs:  The SEC would be required to share with the Federal Reserve the reports filed by registered advisers to allow the Federal Reserve to determine whether any funds are Tier 1 FHCs and therefore should be subject to the incremental regulation that is applicable to Tier I FHCs.
  • Conflicts of Interest:  Importantly for banks that sponsor or advise private investment vehicles, the White Paper proposes that (i) existing federal restrictions on transactions between banks and their affiliates be applied to transactions between a bank and all private investment vehicles sponsored or advised by the bank, (ii) the Federal Reserve’s discretion to provide exemptions from the bank/affiliate firewalls be limited, and (iii) the Federal Reserve and the federal banking agencies tighten the supervision and regulation of potential conflicts of interest generated by the affiliation of banks and other financial firms, such as private investment vehicles.


Beyond “modest,” the White Paper does not define the threshold that would trigger the registration requirement for fund advisers, although given the current environment we expect the threshold in any final regulation to be quite low. As an indication of current Congressional thinking on this issue, Senator Jack Reed (D., R.I.) has proposed, in connection with the Private Fund Transparency Act of 2009 he introduced on June 16, 2009, to require advisers with $30 million or more in assets under management to register.

The White Paper generally does not include details on the scope of the regulatory requirements that would apply to funds advised by registered advisers (e.g. the extent of required disclosure regarding investments), although it suggests that these requirements could vary by fund type.  The White Paper does provide limited insight on the substance of regulatory reporting by proposing that advisers report to the SEC, on a confidential basis, the amount of assets, borrowings and off-balance sheet exposures of the funds they manage, and other information necessary to assess whether a fund or fund family is so large, highly leveraged or interconnected that it poses a systemic threat to financial stability.

Regulation of a private fund as a Tier 1 FHC would represent a dramatic increase in the regulatory burden and supervision of private funds.  A fund designated a Tier 1 FHC would be subject to conservative capital, liquidity and risk management requirements, and as a practical matter many funds may be forced to restructure their activities in a manner designed to avoid designation as a Tier 1 FHC.  In addition, the White Paper appears to suggest that regulators would have the authority to intervene to prevent a disorderly dissolution of a fund designated as a Tier 1 FHC where the dissolution might have serious adverse effects on the financial system or the economy.

The White Paper indicates that Tier 1 FHCs would be regulated like bank holding companies but have a five year period to conform to the “nonfinancial” activity restrictions imposed on financial holding companies.  It does not indicate whether any other exceptions to bank holding company rules would be available to hedge funds and other private investment vehicles.

Finally, if private fund advisers are required to register with the SEC, and the SEC is to make consumer field surveys, establish new standards of conduct for broker-dealers dealing with their customers, regulate CDSs, increase surveillance of credit rating agencies, and conduct relevant inspections and examinations in all of these areas, the SEC will need significantly increased staff, with additional areas of expertise, and significant new resources.

G. Money Market Mutual Funds

The Administration encourages the SEC to implement its plan to strengthen regulation of money market mutual funds to reduce their systemic risk and proposes that the President’s Working Group on Financial Markets report on possible further steps that could enhance MMMFs’ stability.


The Administration had considered removing MMMF oversight authority from the SEC and locating it in the new Consumer Financial Protection Agency.  A different position prevailed.

H. Office of National Insurance

The plan proposes to establish the Office of National Insurance, to be located in the Treasury Department, to coordinate federal policy for the insurance industry and to negotiate international agreements.


The insurance industry has expressed support for the White Paper — or at least its goals — most likely as a step toward an optional federal insurance charter.  The American Council of Life Insurers has criticized the state system of insurance regulation and “strongly supports” the creation of an optional federal insurance charter and advocates the eventual establishment of a federal functional insurance regulator.

I. Government Sponsored Enterprises

The plan proposes that Treasury, the Department of Housing and Urban Development, and other federal agencies work together to determine the future of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks.

The proposal lists six possible (though non-exclusive) options for the reform of GSE’s, as follows:

1.  returning the entities to their previous status as GSEs, with a goal of maximizing value for shareholders while pursuing some housing goals;

2.  wind-down and liquidation;

3.  incorporating their functions into a federal agency;

4.  regulating them like public utilities (e.g., rate-setting and a government backstop);

5.  converting them to providing insurance for covered bonds; and

6.  dissolving Fannie Mae and Freddie Mac into multiple, smaller companies.

II.  Regulation of Financial Markets

Though the Administration praised innovation in the markets, it recognized that the evolution of new financial products and practices has allowed much of the securities and derivatives markets to go unregulated or to be subject to inconsistent regulation.

A. Market Transparency

The Administration criticized the securities markets for breaking down the traditional relationship between borrowers and lenders, which created conflicts of interest.  The Administration proposes to require the originator or sponsor to maintain an economic interest in any securitized credit exposure.  Moreover, the plan would increase reporting requirements imposed on issuers of asset-backed securities.

B. Credit Rating Agencies

The Administration’s plan would increase regulation of credit rating agencies, work to decrease conflicts of interest, and reduce the government’s reliance on the agencies’ ratings whenever possible.


Neither the SEC nor the Fed has been able to reduce their use of and dependence on credit ratings to date — because there is no easy substitute available.   The White Paper makes no distinction between “nationally recognized statistical rating organizations” and other credit rating agencies.

C. Over-the-Counter Derivatives

The Administration Proposal would bring all OTC derivatives into a regulatory framework.  The plan sets forth four goals for the framework, including 1) reducing risk to the financial system; 2) promoting transparency of the OTC market; 3) preventing market manipulation and fraud; and 4) preventing the marketing of complex OTC derivatives to financially unsophisticated parties.

The Proposal calls for Congress to amend the Commodities Exchange Act to allow the CFTC and the SEC to regulated derivatives.  The Proposal would require all standardized” derivatives to be cleared through central counterparties (CCPs) and would subject all derivatives trading to reporting requirements.  The CCPs would be required to impose “robust” margin requirements to prevent systemic risk and would have to establish controls so that customized derivatives will not be used to avoid clearing.


The White Paper would treat standardized and non-standardized derivatives differently, though it’s not clear how the Administration would draw the line between the two.  The proposal would amend the Commodities Exchange Act and securities laws to “require clearing of all standardized OTC derivatives through regulated central counterparties,” which are to impose “robust margin requirements” and “other necessary risk controls.”  The proposal would impose “conservative capital requirements” on OTC derivatives dealers and other firms that “create large exposures to counterparties” through derivatives use.  Heightened capital requirements are also to apply to OTC derivatives that are not centrally cleared.  One question, though, is whether liquid collateral would be required to meet such requirements.  Such a requirement could pose challenges to firms — and particularly non-financial firms — that currently use OTC derivatives and are able to post non-liquid collateral.

D. The SEC and CFTC

Though many plans have been floated that would merge the SEC and the CFTC, the Obama Administration has chosen not to instigate the turf battle that likely would emerge between the two agencies and the Congressional committees that have jurisdiction over them.  Instead, the Administration proposes to “harmonize” the regulation of securities and futures.  The plan recommends that the Fed oversee payment, clearing, and settlement systems and that those systems have access to the Federal Reserve’s bank accounts, financial services, and discount window.


These are laudable goals but, based upon the rancor that has generally attended jurisdictional battles between government agencies and Congressional committees, even the Administration’s modest goal may not be achieved.  The Proposal also begs the question – will the harmonization of the SEC and the CFTC also mean the harmonization of the Financial Industry Regulatory Authority and the National Futures Association?

III.  Consumer and Investor Protection

A. Consumer Financial Protection Agency

The Administration proposes the creation of a Consumer Financial Protection Agency (CFPA), to protect consumers of credit, savings, payment and other consumer financial products and services.  The impetus for the proposal is the need to protect consumers from abusive practices  (i) in the market for sub-prime and nontraditional mortgages and (ii) relating to credit cards.  The proposal is to create a single regulatory agency – the CFPA – charged with (i) reducing enforcement gaps, (ii) improving coordination with states, (iii) setting standards for financial intermediaries (like debt counselors), and (iv) promoting consistent regulation of similar products.  The CFPA is designed to consolidate consumer protection power not already delegated to the SEC or FTC and create a “culture of consumer protection.”  The Administration faults existing bank regulatory agencies for viewing the world “through the lenses of institutions and markets, not consumers.”

The CFPA would have the authority to write rules, supervise and examine institutions’ compliance, and administratively enforce violations.  The CFPA would assume all responsibility from the federal prudential regulators for supervising bank compliance with consumer regulations, and its jurisdiction will extend to bank affiliates that are not currently supervised by a federal regulator.

The CFPA would be assembled from the consumer compliance supervision divisions of the four federal banking agencies and the rule-writing division of the Federal Reserve.  The CFPA would have a Director and a Board, at least one member of which will be the head of a prudential regulator.  The CFPA may be funded in part from fees assessed on entities and transactions related to covered products and services.

Under the Proposal, the CFPA would have sole authority to promulgate and interpret regulations under existing consumer financial services and fair lending statutes along with any future laws addressing consumer protection with regard to consumer credit, savings, collection, or payment.

The proposed CFPA would have enforcement power over covered institutions, including subpoena authority for documents and testimony and the capacity to compel production by court order.  In addition, the CFPA would have the authority to restrict or ban mandatory arbitration clauses.


The CFPA proposal has incited praise from key committee chairmen on Capitol Hill and concern from key business trade associations.  One thing is certain; the proposal will be the subject of robust Congressional debate.

A number of aspects of the Agency and questions raised by the proposal bear mention.

Under the proposal, the CFPA is empowered to require that providers offer “‘plain vanilla’ products that are simpler and have straightforward pricing… alongside whatever other lawful products they choose to offer.”  This ability to require that private companies offer specific “plain vanilla” financial products seems remarkable for the extent to which it potentially replaces the business judgment of private enterprise with government agency policy decisions.  For example, would the CFPA have authority to determine whether a private company is required to offer a five year ARM versus a thirty year fixed rate mortgage as a “plain vanilla” product alongside some even more complex “alternative” mortgage or sub-prime product, and to what extent would the agency have power over pricing of these “plain vanilla” products.  One private sector reaction might be to offer the “plain vanilla” product but price it high enough that rational consumers would not select it.  Indeed, the language in the proposal that “the CFPA be authorized to place tailored restrictions on product terms” suggests that even pricing decisions could be taken away from the private sector.

Under the proposal, there would appear to be room for arbitrage among state insurance regulators, the new CFPA, the SEC, and other regulatory agencies.  Products that are marketed to consumers/investors for the same purposes will be regulated differently.  Such arbitrage could detract from the Agency’s effectiveness.

Another question concerns agency overlap. The proposal would shift much authority for financial products and services from the FTC to the new CFPA.  Will the FTC staff move as well?  The FTC would retain authority over financial fraud, credit repair, debt negotiation and foreclosure fraud, ostensibly at the same time that this authority is also being vested in the CFPA.  How will the agencies deal with this overlap of authority?

A further issue, raised by the Financial Services Roundtable, concerns the separation of regulation of entities from regulation of products.  As the Roundtable puts it, “each regulator will only have half of the information.”  It is unclear whether separating the regulation of safety from soundness will produce a more effective regime.

Finally, the proposal would set a “floor, not a ceiling” for regulation, thus explicitly permitting states to impose stronger standards.  Preemption is historically a difficult issue to shepherd through Congress.  In this case, the difficulty is likely to be compounded due to the strength of parties in interest on both sides of the issue.

The head of the American Bankers Association has predicted that “the inclusion of the highly controversial Consumer Financial Protection Agency will undermine chances of enactment of needed reform.”

B & C. Strengthen Consumer and Investor Protection

The Proposal seeks to make all mandatory disclosure forms clear, simple, and concise, and to require regular testing of forms, including field testing.  The CFPA would be authorized to issue “no action letters” to providers regarding disclosures and other communications for new products.  The CFPA would also be authorized to define standards for simpler “plain vanilla” products with straightforward pricing.  All providers could be required to offer these products along with their other offerings.

The CFPA will have the authority to adopt tailored protections against unfair or abusive practices.  Such protections may include mandating disclosures or restrictions on contract terms or sales practices.  The Proposal also recommends that the CFPA be given the authority to impose duties of care on financial intermediaries.

The Administration recommends that the SEC be given the authority to require that certain disclosures, such as the summary prospectus, be provided to investors at or before the time of sale.  The SEC should also be able to establish a fiduciary duty for broker-dealers offering investment advice, as is currently attributed to investment advisors.  The SEC would also be authorized to ban forms of compensation that incentivize intermediaries to recommend products that are not in investors’ best interest.  The SEC would also be granted the authority to prohibit mandatory arbitration clauses in broker-dealer and investment advisory accounts with retail customers.  Under the Proposal, the SEC would also have the ability to establish a fund to pay whistleblowers and expanded options for sanctions available in enforcement actions.

The Administration also recommends granting the SEC the authority to implement “say on pay” rules, which require non-binding shareholder votes on executive compensation packages.

The Financial Consumer Coordinating Council would be organized under the Financial Services Oversight Council, and would include the heads of the SEC, FTC, Department of Justice, and CFPA.  The Financial Consumer Coordinating Council would be responsible for identifying gaps in consumer protection across financial products.

The FTC will retain authority for dealing with fraud in the financial marketplace but, at the same time, parallel authority is provided to the CFPA.  The Administration also urges Congress to give the FTC more resources to “do its job effectively.”


The SEC already has ample statutory authority to require “real time” disclosure at the point of sale and to increase transparency standards and, if it adds staff, to expand “consumer testing” regarding disclosures.

Harmonizing standards of conduct for broker-dealers and investment advisers is probably a laudable goal, but has to be done carefully as many customers use brokers just or primarily for order execution and, in such circumstances, it is not appropriate to say that the broker is a “fiduciary.”  Functional regulation is more appropriate — based on the type of services that are provided.

The White Paper’s definition of “incidental advice” picks up research that’s provided by broker-dealers together with execution services.  An unintended consequence would be that brokers stop providing retail clients research so that they’ll have less information available, particularly with expiration of research settlement this fall and the requirement to provide independent research.

“Say on pay” is likely to pass  in some form with or without comprehensive financial regulation; it presents some practical problems (e.g., exactly what are shareholders voting on?), but they can be addressed through preparation.  One might question the idea of having both a Financial Consumer Coordinating Council and an SEC Investor Advisory Committee on a permanent basis.  History tells us that such permanent advisory groups often produce little of value.  A bipartisan, truly expert and broadly representative ad hoc group that is given a specific mission to study the issues and to make concrete recommendations in a finite time period will be far more effective and far more credible….and there already is one of those.

IV.  Government Tools to Manage Financial Crisis

A. Resolution Authority

The White Paper proposes the creation of a special resolution regime based on the existing resolution regime for insured depositary institutions under the Federal Deposit Insurance Act (FDIA).  The Administration believes that the lack of existing statutory framework for avoiding the disorderly failure of non-bank financial firms, including affiliates of banks or other insured depositary institutions gives the Administration only two alternatives:  bail out the institution (as was done in AIG or Bear Stearns) or let it go through a disorderly failure (as was done in Lehman).  The proposed regime would allow for orderly resolution of failing bank holding companies and non-bank financial firms, where the stability of the financial system is at risk.

The Administration has stated that although the United States Bankruptcy Code will continue to be the dominant tool for handing the failure of a bank holding company, this proposed special resolution regime, will allow the government to depart from the Bankruptcy Code standard, when the financial stability of the US economy is at risk.

The process for the resolution of a failed or failing firm under the proposed special resolution regime can be initiated by the Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation, or the Securities and Exchange Commission, if the largest subsidiary of the failing firm is a broker-dealer or securities firm.

The authority to decide whether to use this special resolution regime will be with the Treasury, which could invoke it after consultation with the President, and only upon the written recommendation of two thirds of the members of the Federal Reserve Board and two thirds of the members of the FDIC board.  If the largest subsidiary of the firm (measured by total assets) is a broker-dealer then the FDIC approval is not needed, but two thirds of the commissioners of the SEC must approve.  If the failing firm includes an insurance company, the Office of National Insurance within the Treasury would provide consultation on insurance matters.

To invoke the authority, the Treasury would have to determine that (1) the firm is in default or in danger of defaulting, (2) the failure would result in serious adverse consequences to the financial system or the economy, and (3) the use of the special resolution regime would avoid or mitigate these adverse effects. In making such determination, the Treasury should consider the action’s cost to taxpayers and the actions potential for increasing “moral hazard.”

Once the decision has been made to use the special resolution regime, the Treasury can, at this point, appoint a conservator or receiver for the resolution of the firm, who will typically be the FDIC, or the SEC if the largest subsidiary of the firm is a broker-dealer or securities firm.

The White Paper proposes granting the conservator or receiver appointed by the Treasury broad powers similar to those provided by the FDIA, including the ability to control the operations of the firm and the ability to sell all or part of the assets of the firm.  In addition, the conservators or receiver would also be able to transfer derivatives contracts to bridge institutions.  In the event that such derivatives contracts are transferred, the non-debtor counterparty would not be able to exercise its contractual rights to terminate such contracts based on the appointment of a receiver.  Conservators and receivers can also renegotiate or repudiate any of the firm’s contracts.

Assistance to the firm will be through loans from the Treasury, and may be financed by the issuance of public debt.  The loans would be repaid by assessments on other bank holding companies.  Such assessments would be based on the total liabilities of such bank holding company, not including liabilities assessed to fund other federal or state insurance schemes.

The resolution regime proposed under the White Paper can be applied to any bank holding company, regardless of size as long as the Treasury makes the determination that the financial system or the US economy is at risk.  As the special resolution regime is exceptional relief, firms will not have a clear idea of whether they will be subject to the new resolution regime or the Bankruptcy Code, until the Treasury initiates the resolution process.  The White Paper is silent on whether the Treasury could institute special resolution proceedings against an entity already in bankruptcy.

The special resolution regime would also be funded by the Treasury funds, rather than by an insurance system similar to the FDIA.  The White Paper also fails to address whether and how the government’s assistance would be repaid (as a priority creditor, by the government taking a stake in the reorganized company).  In addition, it also fails to address how assets of a firm in conservatorship or receivership would be valued, how secured creditors would be treated and whether there would be any minimum or maximum threshold for creditor recoveries.


The Administration’s proposal to create a resolution process for systemically significant institutions leaves a number of key questions unanswered.  Among them are the following:

  • It is unclear which firms would be subject to a special resolution regime and what the White Paper means by “the action’s potential for increasing moral hazard” in determining whether or not to institute the special resolution regime.  Post hoc determination of resolution regime’s applicability creates uncertainty as to which rules apply and prevents firms and its creditors from preparing for the firms failure.
  • What public information if any will be available to creditors?  In a case under the Bankruptcy Code, creditors have access to information about the company, its assets, and liabilities.  What protections will there be for secured and general creditors? How will assets be valued in a receivership or conservatorship?
  • Will there be any judicial or other review of any actions taken by the conservator/receiver, including in the claims process?  In a case under the Bankruptcy Code, all significant actions, outside the ordinary course of business are subject to review by the relevant federal bankruptcy court and creditors are provided with advance notice with respect to such actions and have standing to challenge or object to such actions.
  • Could the Treasury institute special resolution regime proceedings against an entity already in bankruptcy, and if so, how would such existing relief be treated?
  • It is unclear which bank holding companies will be subject to post hoc assessments to repay government assistance.  Will there be a size limit on both the bank holding company assessed or any limits to the amount of a potential assessment?  Could the bank holding company challenge an assessment?  Would the firm subject to the special resolution regime have any obligation to repay such assistance (if so what would the priority of the government claim be), or would all recoveries go to creditors?
  • What derivatives contracts would be included?  Would this be the whole scope of qualified financial contracts, including repurchase agreement, securities lending transactions, etc.?  If the contracts are transferred to the bridge institution, and creditors can no longer exercise contractual rights to terminate based on the appointment of a receiver, would that affect security posted in connection with such contracts?  Could derivatives contracts be “cherry picked” such that set-off and netting rights of counterparties would be affected?

B. Federal Reserve Emergency Lending Authority

Under Section 13(3) of the Federal Reserve Act, the Federal Reserve Board may authorize the Federal Reserve Bank to lend in “unusual and exigent circumstances.”  The Proposal recommends that Section 13(3) be modified to require the prior written approval of the Secretary of the Treasury for such emergency lending.

V.  International Regulatory Standards and International Cooperation

A persistent theme during Congressional hearings on the financial crisis has been the need to promote consistent international regulatory standards, both to prevent businesses from leaving the United States and to prevent global “race to the bottom” by countries seeking to attract business with lax regulations.  The Obama Administration pledged in the White Paper to work with the G-20, the Financial Stability Board, and the Basel Committee on Banking Supervision to promote strong financial regulation internationally.

Many of the Administration’s Proposals in the international section track its plans for the United States, such as encouraging national authorities to require hedge fund registration and disclosures, strengthening prudential regulation for financial firms, aligning executive compensation with safety and soundness goals, and improving accounting standards and credit rating agencies.  Other portions of the Administration’s international plan encourage the strengthening of Basel II, the standardization of derivative markets, increasing international supervision over internationally significant financial firms, improving information sharing, completing the Financial Stability Board’s restructuring by September 2009, and imposing higher liquidity standards on international firms.

Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, [email protected]) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group:

Public Policy Expertise
Mel Levine – Century City (310-557-8098, [email protected])
John F. Olson – Washington, D.C. (202-955-8522, [email protected])
Amy L. Goodman – Washington, D.C. (202-955-8653, [email protected])
Alan Platt – Washington, D.C. (202- 887-3660, [email protected])
Michael Bopp
– Washington, D.C. (202-955-8256, [email protected])

Securities Law and Corporate Governance Expertise
Ronald O. Mueller – Washington, D.C. (202-955-8671, [email protected])
K. Susan Grafton – Washington, D.C. (202- 887-3554, [email protected])
Brian Lane – Washington, D.C. (202-887-3646, [email protected])
Lewis Ferguson – Washington, D.C. (202- 955-8249, [email protected])
Barry Goldsmith – Washington, D.C. (202- 955-8580, [email protected])
John H. Sturc
– Washington, D.C. (202-955-8243, [email protected])
Dorothee Fischer-Appelt – London (+44 20 7071 4224, [email protected])
Alan Bannister – New York (212-351-2310, [email protected])
Adam H. Offenhartz – New York (212-351-3808, [email protected])
Mark K. Schonfeld – New York (212-351-2433, [email protected])

Financial Institutions Law Expertise
Chuck Muckenfuss – Washington, D.C. (202- 955-8514, [email protected])
Christopher Bellini – Washington, D.C. (202- 887-3693, [email protected])
Amy Rudnick – Washington, D.C. (202-955-8210, [email protected])
Dhiya El-Saden – Los Angeles (213-229-7196, [email protected])
Kimble C. Cannon – Los Angeles (213-229-7084, [email protected])
Rachel Couter – London (+44 20 7071 4217, [email protected])

Corporate Expertise
Howard Adler – Washington, D.C. (202- 955-8589, [email protected])
Richard Russo – Denver (303- 298-5715, [email protected])
Dennis Friedman – New York (212- 351-3900, [email protected])
Stephanie Tsacoumis – Washington, D.C. (202-955-8277, [email protected])
Robert Cunningham – New York (212-351-2308, [email protected])
Joerg Esdorn – New York (212-351-3851, [email protected])
Wayne P.J. McArdle – London (+44 20 7071 4237, [email protected])
Stewart McDowell – San Francisco (415-393-8322, [email protected])
C. William Thomas, Jr. – Washington, D.C. (202-887-3735, [email protected])

Private Equity Expertise
E. Michael Greaney – New York (212-351-4065, [email protected])

Private Investment Funds Expertise
Edward Sopher – New York (212-351-3918, [email protected])
Jennifer Bellah Maguire – Los Angeles (213-229-7986, [email protected])

Real Estate Expertise
Jesse Sharf – Century City (310-552-8512, [email protected])
Alan Samson – London (+44 20 7071 4222, [email protected])
Andrew Levy – New York (212-351-4037, [email protected])
Fred Pillon – San Francisco (415-393-8241, [email protected])
Dennis Arnold – Los Angeles (213-229-7864, [email protected])
Michael F. Sfregola – Los Angeles (213-229-7558, [email protected])
Andrew Lance – New York (212-351-3871, [email protected])
Eric M. Feuerstein – New York (212-351-2323, [email protected])
David J. Furman – New York (212-351-3992, [email protected])

Crisis Management Expertise
Theodore J. Boutrous, Jr. – Los Angeles (213-229-7804, [email protected])

Bankruptcy Law Expertise
Michael Rosenthal – New York (212-351-3969, [email protected])
David M. Feldman – New York (212-351-2366, [email protected])
Oscar Garza – Orange County (949-451-3849, [email protected])
Craig H. Millet – Orange County (949-451-3986, [email protected])
Thomas M. Budd – London (+44 20 7071 4234, [email protected])
Gregory A. Campbell – London (+44 20 7071 4236, [email protected])
Janet M. Weiss – New York (212-351-3988, [email protected])
Matthew J. Williams – New York (212-351-2322, [email protected])
J. Eric Wise – New York (212-351-2620, [email protected])

Tax Law Expertise
Arthur D. Pasternak – Washington, D.C. (202-955-8582, [email protected])
Paul Issler – Los Angeles (213-229-7763, [email protected])

Executive and Incentive Compensation Expertise
Stephen W. Fackler – Palo Alto (650-849-5385, [email protected])
Charles F. Feldman – New York (212-351-3908, [email protected])
Michael J. Collins – Washington, D.C. (202-887-3551, [email protected])
Sean C. Feller – Los Angeles (213-229-7579, [email protected])
Amber Busuttil Mullen – Los Angeles (213-229-7023, [email protected])

© 2009 Gibson, Dunn & Crutcher LLP

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