In the wake of the historic melt-down of the economy, Congress is close to adopting legislation to restructure the financial services regulatory system. The Wall Street Reform and Consumer Protection Act of 2009 was approved by the U.S. House of Representatives in December, but it has been harshly criticized from both the right and the left as being too much and too little. Details are still being negotiated in the Senate. Exactly how the new law will work, and whether it will prevent future financial collapse, remains to be seen as Congress grapples with reconciling the different parallel bills.  

Meet the New Boss

Under the House legislation a “systematic risk regulator” -- called the Federal Stability Oversight Council – will be created. The Council, which is intended to monitor the marketplace to identify threats to the stability of the financial system, would be chaired by the Secretary of the Treasury and consist of the top financial regulators, including the heads of the Federal Reserve Board, SEC, FDIC, Federal Housing Finance Commission, and the Consumer Finance Protection Agency.  

The Council will be responsible for advising Congress on financial regulations and for making recommendations to enhance the integrity and stability of the financial markets. These goals are laudatory and non-controversial, but are already being provided under the current regulatory regime. The only certain change that can be expected now will be an increase in reporting and regulatory requirements.  

Ain’t Nothing But A Watchdog: Consumer Financial Protection Agency

One of the more controversial aspects of the legislation is the creation of a Consumer Financial Protection Agency (CFPA). The CFPA’s goal is to “seek to promote transparency, simplicity, fairness, accountability and equal access in the market for consumer financial products and services.” The Agency would also have authority to take action to prevent unfair, deceptive or abusive practices in connection with financial products, including mortgages and credit cards.  

The CFPA mirrors the responsibilities of other agencies regulating consumer financial products and services. Nevertheless, financial institutions are strongly opposed to this portion of the legislation. This new financial consumer watchdog agency is one of the obstacles to a compromise in Congress. In a concession to Republicans, the current Senate bill would allow other regulators to overturn proposed CFPA rules, and would place the CFPA within the Federal Reserve.  

Working for Who? Stockbrokers and Investment Advisors

The new law will impose additional disclosure requirements on broker/dealers and investment advisors, and will codify a fiduciary duty standard. In the past, investment firms and broker/dealers could defend against lawsuits by asserting that they were not subject to a fiduciary duty to investors, in spite of marketing their services to be in the best interest of the customer.  

Under the new law, every broker/dealer and investment advisor providing personalized investment advice will owe a fiduciary duty to act in the best interest of the customer. Perhaps the most shocking thing about this concept is that it is considered “new”.  

The Change It Had to Come: Securities Arbitration

Most investors do not realize that when they open an account with any of the major brokerage firms, the account opening forms include a mandatory arbitration provision. This provision waives the investor’s right to go to court and requires binding arbitration in a securities industry controlled forum, in the event of any dispute regarding the investor’s account. Congress has finally realized that such arbitration provisions have unfairly restricted the ability of defrauded investors to seek redress in the courts for wrongdoing by investment advisors and brokerage firms.  

However, while recognizing the inequity of the securities arbitration system, Congress failed to take the necessary corrective action of prohibiting mandatory securities arbitration. Instead, Congress passed the buck to the SEC on this critical issue. Under the new law, the SEC would have the power to restrict or even prohibit broker/dealers' and investment advisors' use of mandatory arbitration contracts. It is unclear how the SEC will deal with this issue.  

Risky Business: Hedge Funds and Collateralized Investments

The new law will greatly expand regulation of hedge funds and private equity funds, which are currently not subject to the same standards as banks and mutual funds. The past exemption allowed private funds to operate largely outside of the financial regulatory system because their investors were supposedly more sophisticated and required less protection.  

The new law also adds some protection in the sale of asset-backed securities, such as mortgage-backed securities, which have been exposed in the past as frequently not backed by assets of adequate value. Under the new law, companies that sell collateralized securities will be required to retain at least 5% of the securities themselves. The hope is that the new law will ensure that financial institutions that sell these products are not selling collateralized garbage to the public.  


Many observers believe that Congressional Democrats may have pushed the limits of their power with the health care bill, and therefore will have to scale back some of the more controversial aspects of the financial reform legislation. The proposed Consumer Financial Protection Agency is already being eyed as a target, perhaps to be declawed if not eliminated entirely