On March 15, 2010, Senate Banking Committee Chairman Christopher Dodd (D-CT) released a revised draft of financial regulatory reform legislation, the Restoring American Financial Stability Act. After a 20 minute markup, on March 22, the Senate Banking Committee voted along party lines, 13-10, to report Chairman Dodd's bill to the full Senate for consideration, as modified by a Manager's Amendment (which was adopted by voice vote). The Senate action on financial regulatory reform legislation follows the passage by the House of Representatives on December 11, 2009 of its version of financial regulatory reform, H.R. 4173, the Wall Street Reform and Consumer Protection Act.

This is one in a series of alerts that will discuss the details of the proposed legislation and the potential impact it may have on the financial services industry if adopted in substantially its current form. This alert focuses specifically on the effects of Chairman Dodd's bill on bank holding companies ("BHCs") and savings and loan holding companies ("SLHCs"), as compared to the potential effects under the House-passed H.R. 4173. The establishment of the Financial Stability Oversight Council and its implications for the "Too Big to Fail" doctrine, the impact of potential restrictions on proprietary trading under the "Volcker Rule" and the future of federal preemption over state law if Chairman Dodd's bill's preemption standards become law will be discussed in separate alerts. The potential effects of Chairman Dodd's bill and H.R. 4173 on federal thrifts were discussed in a previous alert.

A. New Regulatory Regime for BHCs and SLHCs

Chairman Dodd's bill would effect a "sea change" in the system of prudential bank regulation that has existed for the past 80 years by, among other things, transferring supervisory authority over BHCs and SLHCs with consolidated assets of less than $50 billion (the proposed threshold for systemically important institutions1) to the Office of the Comptroller of the Currency ("OCC"), which would regulate holding companies of national banks and federal thrifts with total consolidated assets under $50 billion, and the Federal Deposit Insurance Corporation ("FDIC"), which would regulate the holding companies of state banks and thrifts with total consolidated assets under $50 billion. While Chairman Dodd asserts that his bill would "streamline bank supervision with clear lines of responsibility, reducing arbitrage and improving consistency and accountability," the end results of the legislation, if enacted, will be that all BHCs and SLHCs with less than $50 billion in consolidated assets will experience a change in their primary federal regulator at the holding company level.

Chairman Dodd's bill distinguishes between BHCs and SLHCs that are "systemically important" and those that are not. Under Chairman Dodd's bill, BHCs and SLHCs with $50 billion or more in consolidated assets will be subject to the supervisory authority of the Board of Governors of the Federal Reserve System ("Federal Reserve"), which is required to impose "enhanced prudential standards" on them. Such enhanced prudential standards would include stricter risk-based capital requirements, leverage limits and liquidity requirements. As noted above, holding companies of national banks and federal thrifts with consolidated assets of less than $50 billion will be subject to the supervisory authority of the OCC while holding companies of state chartered banks and thrifts with consolidated assets of less than $50 billion will be subject to the supervisory authority of the FDIC. This approach differs from the approach taken in H.R. 4173 in which the Federal Reserve would hold supervisory and rulemaking authority over all BHCs and SLHCs, and the FDIC and the OCC would not have a role in supervising holding companies. Accordingly, under H.R. 4173, only SLHCs would experience a change in their holding company regulator.

Unlike H.R. 4173, Chairman Dodd's bill does not eliminate the SLHC or expressly provide that SLHCs will be regulated as BHCs. Instead, SLHCs will survive with SLHCs of $50 billion or more in consolidated assets being regulated by the Federal Reserve and smaller SLHCs being regulated by the OCC (if they are holding companies of federal thrifts) or the FDIC (if they are holding companies of state chartered thrifts). Chairman Dodd's bill also appears to eliminate the Section 10(l) election which, in effect, currently gives state savings banks that can meet the qualified thrift lender test the power to choose the Office of Thrift Supervision as its holding company regulator. Under Chairman Dodd's bill, this choice will be eliminated and the holding companies of all state chartered banks under the $50 billion of assets thresholds will be regulated by the FDIC and larger SLHCs will be regulated by the Federal Reserve.

Under Chairman Dodd's bill, the distinction between supervisory authority and rulemaking authority is an important one as the Federal Reserve, though it would lose significant supervisory authority over banks and their holding companies, would retain significant rulemaking authority over these institutions. Specifically, the Federal Reserve would have all rulemaking authority over BHCs and SLHCs. Although the FDIC and the OCC would be charged with the supervision of BHCs and SLHCs with less than $50 billion in consolidated assets, the FDIC and the OCC would have little explicit rulemaking authority, which could hamper their supervisory capabilities. However, the Federal Reserve must consult with the FDIC and the OCC before proposing or adopting regulations that apply to BHCs or SLHCs with less than $50 billion in consolidated assets. In addition to the foregoing, the Federal Reserve would have all rulemaking authority over (1) state member banks under the Federal Reserve Act; and (2) transactions with affiliates and loans to insiders.

For additional detail regarding the differences between Chairman Dodd's bill and H.R. 4173, please see Appendix A.

B. Analysis

Effect on SLHCs. As discussed above, unlike H.R. 4173, Chairman Dodd's bill does not eliminate the SLHC or expressly provide that SLHCs will be regulated as BHCs. In addition, by vesting rulemaking authority over SLHCs with the Federal Reserve, existing SLHCs may become subject to consolidated capital requirements, activities restrictions and other new regulatory requirements to which they may not have previously been subject. Chairman Dodd's bill, at a minimum, explicitly applies to SLHCs the "source of strength" doctrine long applicable to BHCs and authorizes (but does not require) the Federal Reserve to adopt consolidated capital requirements for SLHCs.

Incentive to Convert to National Charters. Though Chairman Dodd's bill purports to preserve the dual banking system of federal and state chartered depository institutions, the proposed legislation could cause the largest state chartered member banks to consider converting to a national bank charter. Today, national banks have only two regulators (the OCC at the bank level and the Federal Reserve at the holding company level), and this would continue to be the case under Chairman Dodd's bill for national banks with $50 billion or more in consolidated assets. Similarly, today, state member banks have only two regulators (the state banking commissioner at the bank level and the Federal Reserve at both the bank and holding company level). However, under Chairman Dodd's bill, regulation of state member banks would be shifted from the Federal Reserve to the FDIC, thus adding a third regulator for state member banks and their holding companies with $50 billion or more in consolidated assets (the state banking commissioner and the FDIC at the bank level and the Federal Reserve at the holding company level). The addition of a third regulator would increase the cost and complexity of compliance and create a disadvantage for such institutions compared to national banks with $50 billion or more in consolidated assets. Many state regulators fear that the addition of a third regulator could serve as a "tipping point" that would push large state chartered member banks to convert to national banks. The expanded branching authority for national banks in Chairman Dodd's bill (and referenced in a previous alert) exacerbates this concern. It should be noted that state chartered nonmember banks already have three regulators, and thus already have the disadvantage of multiple regulators, and this would continue under Chairman Dodd's bill for state chartered nonmember banks with consolidated assets of $50 billion or more.

Role of the Federal Reserve. Chairman Dodd's bill has intensified an already heated debate on the appropriate role of the Federal Reserve in bank supervision. While conventional wisdom indicates that Chairman Dodd's bill represents a significant rollback of the Federal Reserve's place in the prudential bank regulatory regime, there is a strong argument to be made that, despite the possible reduction in the number of banks and BHCs that the Federal Reserve would regulate, the Federal Reserve would not experience a significant reduction in its influence under Chairman Dodd's bill. First, under the bill, the Federal Reserve would be required to enact enhanced prudential standards that would include stricter risk-based capital requirements, leverage limits and liquidity requirements in its capacity as the regulator of systemically important institutions. The Federal Reserve would also gain supervisory authority over certain non-bank financial institutions. In addition, the proposed Consumer Financial Protection Bureau would be housed within the Federal Reserve. Perhaps most importantly, as discussed above, the Federal Reserve would have significant rulemaking authority over all BHCs and SLHCs, although it would be required to consult with the FDIC and the OCC before proposing or adopting regulations that apply to BHCs or SLHCs with less than $50 billion in consolidated assets. Thus, the widely held perception that Chairman Dodd's bill would result in a significant reduction in the Federal Reserve's power and influence as a banking regulator may be overstated. However, it should be noted that Federal Reserve Chairman Bernanke has gone on record to argue in favor of the Federal Reserve retaining regulatory authority over all BHCs and state member banks, regardless of size, stating that this is crucial to the Federal Reserve's effectiveness as a regulator of systemic risk and the Federal Reserve's ability to carry out its central banking functions.

It's All About the Regulations. Under Chairman Dodd's bill, the Federal Reserve would be required to enact enhanced prudential standards that would include stricter risk-based capital requirements, leverage limits and liquidity requirements in its capacity as the regulator of systemically important institutions. But the legislation does not provide any detail or direction to the Federal Reserve regarding what form these requirements should take. Instead, the resolution of these issues is left to the Federal Reserve's discretion. Similarly, the substantive changes to consumer protection will be left for the Consumer Financial Protection Bureau to propose regulations. Federal banking regulators already have the authority to adopt regulations to implement such enhanced prudential standards and consumer protection regulations. Therefore, bank, thrifts and their holding companies may have to wait not only for a bill to become law but also for federal regulators to propose and enact regulations before they will know the ultimate impact that regulatory reform will have on them and their operations.

C. Next Steps

With the passage of comprehensive health care legislation, the White House and Congressional leaders have both stated that enacting financial regulatory reform is now their top domestic policy priority. The White House and Senate Democrats have set forth an aggressive timetable for passing financial regulatory reform legislation. The Senate is expected to attempt to take up Chairman Dodd's bill as early as the week of April 26, 2010. Many believe that the recent allegations made by the U.S. Securities and Exchange Commission in its lawsuit against Goldman, Sachs & Co. will provide additional momentum in the Senate for consideration and passage of Chairman Dodd's bill.

While Senate Republicans have threatened to filibuster a motion to proceed to consideration of Chairman Dodd's bill, if Majority Leader Reid is correct that all Democrats and both Independents will support proceeding to consideration of the bill, the support of only one Republican Senator will be required to consider the bill. Once the Senate begins to consider the bill, the amendment process is expected to last two to three weeks and the bill, as amended, is expected to pass the Senate before Memorial Day. This timetable could be accelerated if Chairman Dodd and Ranking Member Shelby are able to reach an agreement to proceed on a bipartisan basis, an outcome that remains a distinct possibility as Dodd and Shelby continue to negotiate and are said to be nearing an agreement.

Chairman Dodd's bill, once passed by the Senate, will then be subject either to a formal conference committee or an informal conference to reconcile the bill with the House-passed financial regulatory reform bill, H.R. 4173. Once a such a conference report is prepared and passed by both the House and the Senate, this legislation will then be sent to the President and become law unless vetoed. The effort by some in the Senate to slow down consideration of Chairman Dodd's bill and the press of other legislative business may extend the timetable for enactment of financial regulatory reform legislation beyond the White House's aggressive goal of having a bill on the President's desk by Memorial Day, but most observers continue to believe that financial regulatory reform legislation will become law this year.