(Image: Terrance Heath/OurFuture.org, Adapted:SEIU International, Tracy O, and harrykeely) by TerranceDC
President Obama signed the Dodd-Frank Act otherwise known as the financial reform bill into law on July 21st. The bill, characterized by Obama as "the most sweeping financial reform legislation since the Great Depression," supposedly created the "strongest consumer financial protections in history."
The legislation created a Bureau of Consumer Financial Protection, imposed regulations on "risky financial instruments," and put in place regulations on credit and debit card fees.
Skeptical of the legislation, I spoke with Mark Perlow, an investment management advisor who works for an investment management practice in San Francisco. Perlow's practice focuses on fund managers (e.g mutual fund managers, hedge fund managers and other investment advisers) and represents a lot of financial firms.
For those wondering, a hedge fund, as defined by Perlow, is "a pool of capital that under Securities Exchange Commission (SEC) rules can't market itself publicly or to investors below a certain level of personal net worth as a way of essentially making sure that only sophisticated investors that can afford to take a lot of risks can invest them. Hedge funds are essentially vehicles that exist to follow investment strategies that mutual funds are not allowed to follow because of SEC rules."
As the financial reform legislation developed and changed in Congress, Perlow followed the evolution. He tracked the bill on behalf of his clients and read much of the bill so that he would be able to advise his clients on how to comply with the new legislation.
"The bill directly affects most of my clients," said Perlow. "I've spent most of the past month following the legislation closely and helping to prepare a series of summaries of the legislation for our clients that are posted on my firm's websites."
The provision that will have the most impact or effect on what Perlow and his clients is "the provision that regulates hedge fund managers" and "private equity managers." According to Perlow, that section will directly affect his client base. And, so will "the section that regulates the derivatives market" because many of his clients "routinely use derivatives as an investment tool."
"The derivatives reform provisions are a complete overhaul of the U.S. derivatives market. It's really a dramatic and comprehensive set of reforms," explained Perlow. "So anybody who deals in the derivatives market" is going to have to understand how those provisions work."
Perlow said the "financial stability provisions" will also "affect all financial firms to a certain degree."
"The Dodd-Frank Act creates a new financial stability oversight council whose job it is to monitor the entire financial sector and to figure out the riskiest parts and decide which ones need more regulation," said Perlow. "So, if you're a large financial firm of whatever type of flavor or stripe, I think that you need to understand the way this new stability oversight council is going to operate."
Perlow mentioned the Volcker rule saying it "would require banks and bank holding companies to either divest or restructure their proprietary trading operations and their hedge fund in private equity management affiliate," and that would affect many of his clients affiliated with banks.
The Volcker rule, according to Business Week, is a proposed rule created by former Federal Reserve chairman Paul Volcker to "curb risk-taking that fueled the financial crisis." The rule had much stronger language to ban banks from running private-equity and hedge funds but was significantly weakened by the addition of language signifying that banks could "invest up to 3 percent of their capital in such funds." Volcker is said to have been disappointed that Congress was unable to ban "banks from trading with their own capital."
Perlow talked about how the bill mainly "creates a framework" for regulators:
"For most of the important provisions in the act, all it really does is it creates a framework. It authorizes the federal financial regulators to write rules into enforcement and gives them a lot of power in order to do that. So, really the effectiveness of the law is going to be dependent to a very large degree on how firm the regulators are and in my line of work everybody recognizes that that the next stage turns to the rulemaking and the enforcement efforts of the SEC, the CFTC, the Treasury Dept, the Federal Reserve and other financial regulators.
If I were a teacher giving this act a grade, I would give it an incomplete because we don't really know how it's going to play out until we see how the regulators are going to implement it."