What Is the Dodd-Frank Act?

The 2008 financial crisis turned the financial markets upside down. The financial disaster was in large part due to the behavior of banks. As a result, the U.S. government instituted a series of "bailouts" administered by the Federal Reserve under the Troubled Asset Relief Program.

Additional Congressional enactments followed as Congress passed financial regulations in response to the crisis. President Obama signed the Dodd-Frank Act into law in 2010. It's also known as the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). It sought to prevent another financial crisis and restore stability and oversight in the financial systems.

Read on to learn more about the Act and how it affects you. See FindLaw's Financial Crisis and Securities Law sections for even more articles.

What Does the Dodd-Frank Act Do?

The Dodd-Frank Act initiated a broad range of reforms affecting nearly every aspect of the financial system. The federal law sought to prevent a repeat of the 2008 crisis and the need for future government bailouts. The Act also sought to establish additional consumer and investor protections.

The Senate subcommittee investigating the financial crisis concluded that the following forces caused the crisis:

• High-risk products in the financial services industry
• Financial institutions' undisclosed conflicts of interest
• Failure to properly regulate credit rating agencies and other financial companies

To address the root causes, the Dodd-Frank Act contains 16 areas of reform. These areas of reform include the following:

• Insurance reform
• Increased reporting requirements
• Corporate governance reform

The Board of Governors of the Federal Reserve System (Board) is responsible for implementing numerous provisions of the Dodd-Frank Act. These provisions include a variety of mandates, including preserving and promoting Minority Depository Institutions.

The Dodd-Frank Act also requires the Board to produce reports to Congress on several topics, which are described in more detail below.

Banking and Financial Firm Reforms

The Act created the Financial Stability Oversight Council. By statute, the Financial Stability Oversight Council (FSOC) must:

• Identify risks to the financial stability of the United States
• Promote market discipline
• Respond to emerging threats to the stability of the U.S. financial system

The FSOC oversees banks and financial firms like hedge funds. Their failure could impact the entire financial system. The FSOC's goal is to remove expectations for future government bailouts.

The FSOC also serves as an early warning system by identifying and responding to emerging threats before they cause widespread damage to the financial system. The FSOC is authorized to:

• Break up banks that are considered too large
• Require banks to increase retention of capital held in reserve, reducing their lending and investing capacities
• Require banks to provide plans for a quick and orderly shutdown in the event they become insolvent
• Provide for orderly liquidation or restructuring of firms considered financially weak

The FSOC seeks to ensure banks do not become too big to fail by imposing strict regulations on financial institutions that pose major risks to the American economy. The Dodd-Frank Act was met with animosity from the financial services industry. Small and mid-tier banks argued the regulations were burdensome and only necessary for the largest banks.

In response, Congress passed a law that loosened some of the regulations for all but the largest banks. Trump-era rollbacks raised the asset threshold for institutions from $50 billion to $250 billion. The Federal Reserve could still apply the Dodd-Frank regulations to banks with at least $100 billion in assets if it chooses to.

Consumer Protections

The Dodd-Frank Act created the Consumer Financial Protection Bureau (CFPB) within the Federal Reserve Board. It's one of the Act's most notable achievements.

The Dodd-Frank Act provides the CFPB with supervisory roles for certain financial firms. The CFPB also serves as a rulemaker and enforcer against practices regarding most consumer financial products or services. Behaviors and actions are prohibited if they are:

• Unfair
• Deceptive
• Abusive
• Otherwise prohibited

The Act transferred most of the FTC's rulemaking authority to the CFPB. The FTC retained all of its enforcement authority and some rulemaking authority. The CFPB regulates companies that sell consumer financial products and enforces laws against discrimination in consumer finance.

The Dodd-Frank Act provided specific relief for consumers victimized by the risky lending practices leading up to the financial crisis. It allocated $1 billion to states and localities to help redevelop foreclosed properties and halt falling property values. Another $1 billion was allocated for bridge loans to help unemployed homeowners cover their mortgage payments until they attain reemployment.

In addition, the Act implemented a series of mortgage reforms to protect consumers. These reforms:

• Require lenders to ensure that homeowners can repay loans
• Require lenders to disclose the maximum a consumer could pay on a variable-rate mortgage
• Remove financial incentives used by lenders to pressure borrowers into more costly loans
• Penalize lenders that violate federal standards by prohibiting them from foreclosing on non-compliant mortgages or allowing the borrowers to recover damages as high as three years' worth of interest payments
• Prohibit pre-payment penalties
• Allow borrowers with high-cost loans to lower their interest rates
• Establish an Office of Housing Counseling to provide counseling on homeownership and rental housing

The CFPB is intended to protect consumers from abusive or risky financial products.

The Volcker Rule

The Act also strengthened the Volcker Rule. The Volcker Rule seeks to prevent speculative trading activities by banks. It prohibits banks from buying or selling securities, derivatives, commodity futures, or options in the banks' accounts.

Five federal financial regulatory agencies have developed and engaged in rulemaking to improve the Volcker Rule. These agencies include the following:

• The Federal Reserve Board
• The Commodity Futures Trading Commission
• The Federal Deposit Insurance Corporation
• The Office of the Comptroller of the Currency
• The Securities and Exchange Commission

The Volcker Rule generally prohibits banks from engaging in the following:

• Proprietary trading of securities, derivatives, and commodity futures for their benefit
• Investing in hedge or private equity funds
• Converting their charters to avoid enforcement actions by the government

Under the Volcker Rule, banks can only trade when necessary for business purposes or when they are working on behalf of customers.

Hedge Fund and Private Equity Rules

In addition, the Act requires hedge funds and private equity advisors to register with the SEC. Hedge funds and private equity advisors must provide information about their trades and portfolios. The SEC must analyze whether the hedge funds or private equity advisors create systemic risks.

The Dodd-Frank Act requires the Federal Reserve to examine a company's nonbank subsidiaries engaging in bank-related activities, such as mortgage lending. The new rules require the Federal Reserve to examine these entities in the same way they would examine a bank conducting such activities.

Dodd-Frank Act Monitors Risky Derivatives

Dodd-Frank requires the SEC or the Commodity Futures Tradition Commission (CFTC) to regulate the most risky derivatives. The Act established a framework for regulating the over-the-counter swap markets. Derivative trading involves contracts between two parties who agree on financial assets to trade for a set period.

Swap dealers are subject to comprehensive regulation under the Dodd-Frank Act. As a result, they must obtain certain representations from their counterparties and otherwise ensure that their swap transactions satisfy the CFTC's swap dealer regulations. Credit default swaps must be regulated by the SEC or the CFTC.

Federal Reserve Reforms

The Dodd-Frank Act restricted the emergency lending or bailout authority of the Federal Reserve by:

• Prohibiting lending to an individual entity
• Prohibiting lending to insolvent firms
• Requiring approval of lending by the Secretary of the Treasury
• Requiring sufficient collateral for any loans to protect taxpayers from losses

In addition, the Act imposed greater transparency on the Federal Reserve. It must disclose all terms and conditions of any emergency lending on an ongoing basis. It also directed an audit of all emergency lending administered by the Federal Reserve during the financial crisis.

Federal Reserve Stress Testing

Following regulations under the Dodd-Frank Act, the Federal Reserve conducts periodic stress tests. If a bank fails to maintain enough capital, the Federal Reserve can take action to ensure the bank remains strong enough to survive a difficult economic time.

The Federal Reserve conducts an annual supervisory stress test for the nation's largest banks and financial institutions. The stress test assesses how large banks would likely perform under hypothetical economic conditions.

Trump-era rollbacks to the Dodd-Frank Act reduced the supervisory stress test and enabled banks not to publicly conduct or report company-run stress tests.

Whistleblower Provisions

There are whistleblower protections in the Dodd-Frank Act. The Dodd-Frank Act contains several whistleblower provisions. Under the whistleblower programs, certain agencies must reward and protect whistleblowers. The whistleblower protections seek to fight corruption and insider trading. Individuals with information about security violations can report it to the government for a financial reward.

Conclusion

The Dodd-Frank Wall Street Reform and Consumer Protection Act created several reforms within the financial system. Many of these reforms impact the litigation process, including creating new legal claims and defenses.

Speaking with an attorney is critical if you face an issue implicating the Dodd-Frank Act. They can explain your legal rights. Find an attorney specializing in securities law today.