Financial Regulatory Reform: President Obama Proposes Additional Financial Reforms Aimed at Large Financial Institutions

January 21, 2010

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is closely tracking government responses to the turmoil that has catalyzed a 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 and oversight issues that we believe could prove useful as firms and other entities navigate these challenging times.

Announcement of Regulatory Reform Proposals

Earlier today, President Obama announced two proposals that he will ask Congressional leaders to incorporate into current banking and financial industry reform legislation.  Flanked by former Federal Reserve Chairman Paul Volcker, the Vice President, and Congressional leaders, President Obama first outlined what he termed the "Volcker Rule," which would prevent commercial banks and other financial institutions from engaging in proprietary trading operations or sponsoring hedge funds or private equity enterprises.  Secondly, with the statement that, "Never again will the American taxpayer be held hostage by a bank that is too big to fail," the President called for a cap on total market share of nondeposit liabilities of any individual bank or "financial firm." No details concerning these two proposals were released today, and it is unclear exactly what institutions and activities will be covered when the full proposals are released.

White House Statement

A White House statement characterized the President’s two new reform initiatives as follows:

1)  "Limit the Scope – The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit. 

2)  "Limit the Size – The President also announced a new proposal to limit the consolidation of the financial sector.  The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms to supplement existing caps on the market share of deposits."

We note the following regarding these proposals:

  • They would extend beyond banks alone to include at least any financial institution that contains a bank.
  • The first proposal draws a distinction between trading operations conducted for the purpose of serving customers and those that are not.  It is not clear how the phrase "unrelated to serving customers" would be defined.
  • By including institutions that contain a bank, the first proposal also would appear to reach the merchant banking activities permitted to financial holding companies under the 1999 Gramm-Leach-Bliley law if such merchant banking activities involve owning, investing in, or sponsoring a hedge fund, a private equity fund, or proprietary trading operations.

The White House statement also noted that:

"In the coming weeks, the President will continue to work closely with Chairman Dodd and others to craft a strong, comprehensive financial reform bill that puts in place common sense rules of the road and robust safeguards for the benefit of consumers, closes loopholes, and ends the mentality of "Too Big to Fail."  Chairman Barney Frank’s financial reform legislation, H.R. 4173, which passed the House in December, laid the groundwork for this policy by authorizing regulators to restrict or prohibit large firms from engaging in excessively risky activities."

Parallels to the 2009 G-30 Reform Proposals

Both restrictions on proprietary trading and limits on nondeposit liabilities holdings were included in a report on financial regulatory reform released last year by a financial reform working group of the Group of 30 former central bankers, or the "G-30," led by Volcker.  Regarding proprietary trading activities, the G-30 stated:

"Large, systemically important banking institutions should be restricted in undertaking proprietary activities that present particularly high risks and serious conflicts of interest.  Sponsorship and management of commingled private pools of capital (that is, hedge and private equity funds in which the banking institutions’ own capital is commingled with client funds) should ordinarily be prohibited and large proprietary trading should be limited by strict capital and liquidity requirements." 

Concerning nondeposit liabilities holdings, the G-30 recommended that:

"To guard effectively against excessive concentration in national banking systems, with implications for effective official oversight, management control, and effective competition, nationwide limits on deposit concentration should be considered at a level appropriate to individual countries."

Presidential Remarks

The President’s remarks were in line with his increasingly aggressive approach to large financial services institutions, also reflected in the proposal last week to charge a fee to the largest banking organizations for the stated purpose of recovering funds expended to stabilize the financial system in 2008-09.  Referencing an "army of industry lobbyists" that have descended from Wall Street onto Capitol Hill, the President said, "If these folks want a fight, it’s a fight I’m ready to have."  He also placed responsibility for the financial crisis squarely in the lap of the banking and financial community, saying that Wall Street firms had caused the financial crisis by taking "huge, reckless risks in pursuit of huge profits."  Finally the President called for overall regulatory reform by stating, "While the system is far stronger today than it was one year ago, it is still operating under the same exact rules that led to its near collapse."

Effects on Financial Regulatory Reform Debate

It is not clear how the President’s proposal will impact the Congressional debate over how to reform our financial regulatory system.  Reactions to the proposal were mixed.  Chairmen Frank and Dodd expressed support for the proposal but expressed different views on how it might impact the Congressional debate.  Chairman Dodd indicated that he would give the proposal "careful consideration as the Committee moves forward on financial reform" and noted with approval the objective of shielding taxpayers from costs associated with "risky activities."  Chairman Frank noted that the House-passed financial reform bill, H.R. 4173, includes language offered by Rep. Kanjorski that would "give the regulators the power to do everything the President has proposed . . . and go beyond those that the President would mandate."  In contrast, House Financial Services Committee Ranking Member Bachus issued a statement stating that the problems the President had identified would be best addressed by a Republican measure, H.R. 3310.  In the end, what will be important is not only whether the Senate (as the House has) adopts the principles articulated today by the President, but how they are expressed in legislation, including whether they are cast as mandates or permissive regulatory authority.

Gibson, Dunn & Crutcher LLP

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, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group:

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