Senator Christopher Dodd, chairman of the Senate Banking Committee, has released his financial regulatory restructuring bill (Dodd Bill). According to the Senator, the Committee will begin to mark-up the bill the week of March 22, 2010. The Dodd Bill would make substantial changes to the regulation of depository institutions. It also contains some significant differences from the bill on the same subject passed by the House last December (House Bill).

Systemic Risk

The Dodd Bill would establish a Financial Stability Oversight Council (Council) made up of representatives of nine financial regulatory agencies. It would be chaired by the Secretary of the Treasury. The Council’s function would be to identify and respond to emerging risks to the U.S. financial system. That would include making recommendations to the Federal Reserve Board (FRB) regarding the regulation and supervision of systemically significant financial companies, including bank holding companies of greater than $50 billion in assets. The FRB would be directed, either on its own or pursuant to Council recommendations, to develop prudential standards for such companies, including risk-based capital requirements, leverage limits, liquidity requirements and concentration limits. The Council would have authority to subject a nonbank financial company (including a foreign financial company with substantial U.S. operations) to regulation by the FRB if it is deemed to pose a risk to financial stability. Regulated systemically significant companies could also be ordered to divest holdings in extreme cases.

The Dodd Bill would create a mechanism for the Federal Deposit Insurance Corporation (FDIC) to act as receiver for failing financial companies where the failure would cause systemic risk. Regulated systemically significant companies would be assessed to build a fund to use for such liquidations. The Secretary of Treasury, the FDIC and the FRB would have to agree to put a company into the liquidation process. In addition, the Dodd Bill would require that a panel of three bankruptcy judges convene and agree that a company was insolvent and should be put into liquidation. Systemically significant companies would also be required to develop and periodically update a “funeral plan” for their rapid and orderly dissolution in the event of failure.

The Dodd Bill includes a provision that makes large financial companies that received TARP funds remain subject to FRB supervision even if they divest their banks. That provision is colloquially referred to as the “Hotel California provision,” after the song by the Eagles (you can check out anytime you want, but you can never leave). It also includes a version of the so-called “Volcker Rule,” which contemplates the adoption of regulations that would restrict bank and bank holding company proprietary trading, investment in and an affiliation with hedge funds and private equity funds.

Bank and Thrift Regulation

The Dodd Bill would substantially restructure the existing regulatory regime for depository institutions. Similar to the House Bill, the Office of Thrift Supervision (OTS) would be merged into the Office of the Comptroller of the Currency (OCC). The federal thrift charter would be eliminated, but existing federals would be grandfathered and regulated by the OCC, along with national banks and federal branches of foreign banks. All state chartered banks and thrifts would be regulated by the Federal Deposit Insurance Corporation (FDIC); state member banks would no longer be regulated by the FRB.

Three holding company regulators are contemplated by the Dodd Bill. The FRB would supervise all bank and savings and loan holding companies with consolidated assets of $50 billion or more and retain regulation-writing authority for all bank and savings and loan holding companies. The OCC would supervise bank and savings and loan holding companies of under $50 billion in assets that have subsidiary national banks or federal thrifts holding the majority of depository institution assets. The FDIC would supervise holding companies of less than $50 billion in assets that have subsidiary state banks or state thrifts holding the majority of the depository institution assets.

The Dodd Bill, like the House Bill, contemplates revising the FDIC’s deposit insurance assessment system to base it on consolidated assets (minus tangible equity capital and long-term unsecured debt). That would replace the existing deposit-based system, unless the FDIC determined that such a change reduces the effectiveness of its risk-based assessment system or increases the risk of loss to the Deposit Insurance Fund.

Federal Reserve Board

In addition to the previously mentioned changes to the FRB’s regulatory authority, the Dodd Bill would change the structure of the FRB and the Federal Reserve System. The position of Vice Chairman for Supervision would be created as a member of the FRB Governors. That person would be responsible for developing policy recommendations regarding supervision and regulation and also reporting to Congress on such matters. To eliminate what Senator Dodd perceives as potential conflicts of interest, the bill would provide that no company, subsidiary or affiliate of a company that is supervised by the FRB would be permitted to vote for Federal Reserve Bank directors. Past or present officers, directors and employees of FRB-regulated entities could not serve as a Federal Reserve Bank director. The Dodd Bill also would make the position of president of the Federal Reserve Bank of New York, which is the only Federal Reserve Bank presidency that has a permanent seat on the Federal Open Market Committee, into a position appointed by the President of the United States, subject to Senate confirmation. That position is currently filled by the Federal Reserve Bank’s directors.

Consumer Agency

The Dodd Bill would establish a “Consumer Financial Protection Bureau” (CFPB). Unlike the House Bill, which would make the consumer agency an independent agency of the Federal Government, the Dodd Bill would place it in the FRB. The head of the CFPB would be a director appointed by the President and confirmed by the Senate. The CFPB would have a dedicated budget under the FRB but the FRB would be prohibited from intervening in the CFPB’s affairs. The CFPB would assume responsibility for financial consumer protection laws and regulations. It would have authority to examine banks, thrifts and credit unions of more than $10 billion in assets, all non-bank mortgage-related businesses such as mortgage brokers and servicers and “larger” providers of other financial products or services for compliance with the consumer laws and regulations. Depository institutions of $10 billion or less would be examined for consumer compliance by the applicable federal depository institutions regulators. The CFPB would also have regulation-writing authority, but its regulations could be overturned by a vote of two-thirds of the Council if determined to present a safety or soundness risk.

The issue of federal preemption of state consumer laws as to national banks and federal thrifts is controversial. The Dodd Bill applies the existing standard announced by the Supreme Court in the Barnett Bank case (but, unlike the House Bill, does so explicitly,) under heightened judicial scrutiny of OCC preemption determinations. Like the House Bill, subsidiaries of national banks and federal thrifts would not receive preemption. The Dodd Bill also authorizes state attorneys general to judicially enforce both federal and state laws against national banks and federal thrifts, including seeking monetary damages.

The Dodd Bill raises a number of issues for regulated depository institutions. For example, while streamlining regulation of depository institutions themselves by removing the OTS and FRB, thereby leaving the OCC and FDIC as Federal depository institution regulators, the bill would actually increase the number of holding company regulators, from two to three, by removing the OTS and adding the OCC and FDIC. State member banks would lose the FRB as their primary federal regulator and become subject to FDIC jurisdiction instead. The Dodd Bill approach, which would result in almost all depository organizations changing at least one regulator, was neither advocated by the Obama Administration’s initial proposal nor contained in the House Bill.

Federal thrifts would not be required by the Dodd Bill to convert to bank charters, but the Bill would eliminate the federal thrift charter and grandfather existing federals. That contrasts with the House Bill’s approach of preserving the federal thrift charter on an ongoing basis, and raises the question of whether the grandfathered federal thrifts would become something of dinosaurs. The prohibition on the issuance of new federal charters also raises the issue of whether existing federal mutual thrifts would have to convert to a bank in order to obtain a stock charter. The Dodd Bill does not contain the explicit language of the House Bill preserving the ability of federal thrift mutual holding companies to waive dividends.

The Dodd Bill would house its consumer protection agency under the FRB. Senator Dodd, at the press conference announcing his bill, repeatedly stressed the agency’s independence and characterized the consumer agency as merely renting space from the FRB. That approach may appease neither those who wanted a completely independent agency nor those that believe that the enforcement of consumer laws is fundamentally tied to safety and soundness and should remain a function of prudential regulators. The Dodd Bill does adopt the concept contained in the House Bill of limiting the consumer agency’s examination authority to only the largest institutions and allowing the federal prudential regulator to examine smaller institutions for consumer compliance. However, industry trade groups have criticized the lack of strong enforcement authority over certain non-bank financial companies that would be subject to the agency’s rules, arguing that depository institutions will continue to be competitively disadvantaged.

There is also continuing controversy over the attempts to legislatively alter the existing parameters of federal preemption for national banks and federal thrifts. Subsequent to the release of the Dodd Bill, the Comptroller of the Currency criticized the preemption provisions as a step in the wrong direction from the House Bill, which the Comptroller found lacking in the first place.

Senator Dodd has said that his bill reflects bipartisan input, although no Republican has publicly announced support. Assuming approval by the Senate Banking Committee, the bill must be passed by the full Senate. It would then go to a Conference Committee, where differences with the House Bill would have to be reconciled. Certain of the Dodd Bills more controversial provisions could be changed during that process.