Dodd-Frank’s Year One Snapshot: Clarity, Confusion and Conflict

Dodd-Frank’s Year One Snapshot: Clarity, Confusion and Conflict

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 quickly spawned an array of regulations intended to avert another financial meltdown, activity that was followed just as quickly by a range of prickly questions and efforts to refine or even dismantle the law.

Dodd-Frank is touted as the most comprehensive financial and securities legislation since the Great Depression, said Thomas More Griffin Gibbons P.C.Designed to regulate the financial services industry, Dodd-Frank’s targets include the insurance and reinsurance industries as well as the significant reform of derivatives. Approximately 24 bills are before Congress to undo parts of Dodd-Frank, he noted.

Griffin along with Linda Kaiser Conley Cozen O’Connor and Francine L. Semay a Legal and Regulatory Consultant, participated in LexisNexis^® webinar held July 20 titled “Dodd-Frank Exposed: What it Really Means to U.S. Business and Consumers.”

Shift in Power

In the United States, insurance and reinsurance regulation, and insurance insolvency, has been primarily left to the states, courtesy of the McCarran Ferguson Act, passed in 1945.  The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 changed all that and has left insurers and reinsurers scrambling to figure out how the new law affects the way they do business.

“With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, the balance of state vs. federal regulation of insurance and reinsurance has been severely altered,” said Semaya, who has for seven years chaired the Federal Involvement in Insurance Regulation Modernization Task Force, part of the ABA Tort Trial & Insurance Practice Section. “While the focus of Dodd-Frank is on regulating financial institutions, other than insurance companies, large insurance companies could be subject to its provisions if such insurers experience financial difficulty.”

Council’s Authority

State regulators and the insurance industry are perhaps most concerned about the far reach of the 10-member Financial Stability Oversight Council (FSOC) and its potential reach. “With a two-thirds vote by this council, regulation of non-bank financial companies, including insurers, by the U.S. Federal Reserve can occur,” Semaya noted.

Quoting a senate committee summary of Dodd-Frank, Semaya said: “A large insurance company or a large insurance holding company deemed financially troubled can well be brought under this new federal regulatory system.” Semaya believes that this would be a result unwelcome to state insurance regulators as well as to a substantial majority of the insurance industry. Of course, the FSOC is required by the new law to consult with state insurance departments before any final determination on regulation of any insurer by the Federal Reserve, she added.

Industry ‘Voice’

“The [FSOC] will clearly be a voice over time as to the issues confronting the insurance industry,” said Conley, a former Pennsylvania Insurance Commissioner, who also spent 12 years as in-house counsel at two multiline insurance companies.

Among its duties, the FSOC will:

• Collect information from government agencies to assess risks to the U.S. financial system;

• Monitor domestic and international financial regulatory proposals and developments, including insurance and accounting issues;

• Require supervision by the Federal Reserve’s Board of Governors for non-bank financial companies (including insurers) that may pose risks to the financial stability of the U.S. in the event of their material financial distress or failure;

• Make recommendations to the Board of Governors concerning the establishment of heightened prudential standards for, among others, nonbank financial companies, such as insurers.

Regulators ‘On the Carpet’

Significantly, the FSOC may issue recommendations to the primary regulatory agencies to apply new or heightened standards and safeguards on insurers that are in financial distress or pose a potential threat to the U.S. financial system. The primary regulator is to receive notice and opportunity to be heard. The primary regulator must implement the recommendations or provide a written explanation as to why the recommendations will be not adopted, noted Conley.

“So this in some sense is calling state regulators a little bit on the carpet to have another agency provide them with input and having a requirement that they consider that input very seriously and justify themselves if the recommendation will not be implemented,” Conley said.

“Of note, there is no provision in Dodd-Frank that requires the opportunity to be heard or the written response from the state regulator be held in confidence,” she pointed out.

Two New Offices A new office established by Dodd-Frank is the Office of Financial Research within the U.S. Treasury Department. Duties include:

• Collecting data regarding, among other entities, non-bank financial companies;

• Standardizing the types and formats of data reported and collected;

• Financial analysis and research;

• Developing tools for risk measurement and monitoring;

• Sharing the results of the Office’s research with regulatory agencies.

Also within the Treasury, the Federal Insurance Office (FIO) is required by Dodd-Frank to study the cost and benefits of potential federal regulation of insurance across various lines of insurance with the exception of health insurance and crop insurance, said Semaya.

International Presence

The FIO will play a significant role in international and global insurance relations. “The FIO will serve as a uniform national voice on insurance matters for the United States on the international stage,” Semaya said.

“Previously, there was no federal government agency or person who was charged with the duty of coordinating international insurance matters with other global regulators,” Conley added.

The FIO will:

• Monitor all aspects of the insurance industry (except for health or crop insurance);

• Gather and analyze data to identify gaps in insurance regulation that could contribute to a systemic crisis in the insurance industry or the U.S. financial system;

• Recommend to the FSOC that it designate an insurer for supervision by the Federal Reserve;

• Coordinate federal efforts in international insurance matters;

• Determine whether state insurance requirements are preempted by international agreements;

• Consult with state insurance regulators regarding matters of national and international importance, such as terrorism;

• Monitor insurance access by traditionally underserved communities and consumers, including minorities and low‐ and moderate‐income persons.

Derivatives Reform

Dodd-Frank completely overhauls the regulation of the derivatives market, which affects mutual funds, hedge funds, banks, broker‐dealers, and end‐users trading derivatives, Griffin said. “I think out of all the provisions in Dodd-Frank, this is the most significant one. What it does is create a worldwide market that can be regulated,” he noted.

Derivatives trading will be regulated through the imposition of clearing, trading, and reporting requirements. Significant market participants will be subject to registration and to capital, margin and conduct requirements. Interagency rulemaking will be required by the U.S. Commodity Futures Trading Commission (CFTC) and the SEC. However, more than approximately 40 derivatives regulations remain unfinished, Griffin added.

Dodd-Frank also deals with regulation of:

• Credit rating agencies such as Moody’s. Dodd‐Frank increases the SEC's ability to monitor rating agency activities and prevent conflicts of interest from harming investors.

• Asset‐backed securities. Most notably, Dodd Frank requires issuers of asset-backed securities to retain credit risk in securitized assets (commonly known as a “skin in the game” requirement).

No More Meltdowns?

Griffin said new Dodd-Frank provisions that impact the securities and financial services industry include:

• New disclosure and recordkeeping requirements on many investment advisers, including some that are not required to register with the SEC.

• More incentives for whistleblowers to report evidence of securities law violations by increasing the size of the award and providing employees a private right of action against employers who retaliate against them for their whistle blowing activities.

Additionally, Dodd‐Frank includes the controversial Volcker Rule, which restricts proprietary trading by U.S. banks and their affiliates, including broker‐dealers, with only limited exceptions, said Griffin. The Volcker Rule authorizes the Federal Reserve Board to impose additional capital requirements on non‐bank financial companies that engage in proprietary trading or that retain equity, partnership or other ownership interests in or sponsor a hedge fund or a private equity fund, subject to certain exceptions.

“These are the kinds of specific provisions that when regulators and politicians were looking at the meltdown they said, ‘What kinds of things can we do to prevent this in the future?’” Griffin explained.

Consumer Protection

Uncertainty surrounds the creation of the Consumer Financial Protection Bureau under Dodd-Frank to regulate the offering and provision of consumer financial products or services. “There’s a lot of legislative push-back to roll back some of what’s in Dodd-Frank in this area,” Griffin said. “It’s too early to tell what’s going to happen at this point.”

Surplus Lines Reform

The Dodd-Frank Act included the Nonadmitted and Reinsurance Reform Act of 2010 (NRRA). The primary purpose of the NRRA’s surplus lines reform is to simplify the payment of surplus lines premium taxes by surplus lines brokers on multistate risks. Under the NRRA, the states – not the surplus lines brokers – determine the allocation of the surplus lines taxes among the various states where the insured has operations or property, Conley pointed out.

As of July 21, only the insured’s home state can levy the surplus lines tax, said Conley. The insured’s home state collects the tax on the entire risk, regardless of where the insured has operations or property. Under the NRRA, for commercial risks, the home state would be the state in which the insured maintains its principle place of business or, if that cannot be determined because 100 percent of the risk is not located in the state, the state with the greatest percentage of the insured’s taxable premium for that insurance policy will receive the premium tax, Conley explained.

Reinsurance Regulation

Changes in the regulation of reinsurance under the NRRA have so far proved to be a disappointment, according to Semaya.

“The act only applies to professional reinsurers, that is reinsurers that do not solicit or issue direct coverage. Therefore, the law does not give any relief to companies that do both direct and reinsurance business,” said Semaya. “Further, until the state laws and regulations are reformed and revised, the law imposed by the NRRA will not be fully operative.”

“At this point I think it’s clear that the changes in the reinsurance reform falls far short of what happens to the non-admitted and surplus lines market, which is much more extensive, although there remain many open issues,” said Semaya. “Overall, reinsurance reform under Dodd-Frank “doesn’t do nearly enough to modernize regulation of the reinsurance industry.”

Wait and See

Semaya said businesses and consumers will have to wait, watch and see what happens with Dodd-Frank as more rules are proposed and more changes are made. “I think the new law is aimed to micromanage and I’m not sure that micromanagement is the way to prevent another economic crisis,” she noted.

Griffin agreed the ultimate impact of Dodd-Frank remains unclear for now. “My view on Dodd-Frank is, it certainly has been like watching a tornado coming – you never know what’s going to happen. But I think the proof will be in the pudding in two or three years if this works to prevent … another major financial collapse.”