Early in his tenure, President Donald Trump stated plans to sign an executive action that establishes a framework for scaling back the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, the Wall Street Journal reports.
The Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly referred to as Dodd-Frank, was signed by President Barack Obama in 2010. After the financial crisis in the late 2000s, Dodd-Frank’s goal was to improve accountability and transparency in the financial system and protect the American taxpayer. Rolling back these measures could have a big impact on board and corporate governance.
According to the U.S. Securities and Exchange Commission, Dodd-Frank contained numerous provisions impacting corporate governance:
- Section 951 requires advisory votes of shareholders about executive compensation and golden parachutes.
- Section 953 requires additional disclosure about certain compensation matters, including pay-for-performance and the ratio between the CEO’s total compensation and the median total compensation for all other company employees.
- Section 955 requires additional disclosure about whether directors and employees are permitted to hedge any decrease in market value of the company’s stock.
As for the impact on corporate boards, Dodd-Frank enables the Securities and Exchange Commission to establish rules that give shareholders access to a company’s proxy statement to nominate board directors. Furthermore, according to an analysis of the law, “the compensation committees of public companies must be composed exclusively of persons who are ‘independent’ and members of the board of directors.”
The Pros and Cons of Dodd-Frank
Proponents of Dodd-Frank believe the law brings more accountability and transparency to the financial sector. Many believe Dodd-Frank could help prevent another Wall Street meltdown. Federal Reserve Chief Janet Yellen told CNN that Dodd-Frank regulations made things “safer and sounder” and after the Trump victory, Yellen said she “didn’t want to see the clock turned back on Dodd-Frank.”
Opponents of Dodd-Frank think otherwise. According to a report by the conservative-leaning Heritage Foundation, “The Case Against Dodd-Frank: How the ‘Consumer Protection’ Law Endangers Americans,” well-intentioned government interventions in the financial market can hurt the consumer. For example, the report blames the 2008 Wall Street crash on risky real estate lending issues, such as subprime mortgages, and not on Wall Street greed.
How will Dodd-Frank impact corporate governance? Here are some specific areas along with their pros and cons:
Proponents of Dodd-Frank say the law brought greater transparency to Wall Street. It recognizes that markets require transparency to work properly and helped re-align incentives through reforms to derivatives and securitization markets, hedge fund reporting requirements and executive compensation, as well as the creation of the Office of Financial Research, according to the U.S. Department of the Treasury.
Opponents of Dodd-Frank welcomed President Trump’s February 2017 signing of legislation striking down a law from Dodd-Frank that requires oil and gas companies to disclose payments to the U.S. or foreign governments, according to USAToday. The oil industry fought to eliminate the rule because they believe that compliance is costly and could hinder U.S. companies’ global competitiveness. According to the Americans for Tax Reform, a conservative advocacy group, the compliance costs of the resource extraction rule would run from $173 million to $385 million annually.
One of the main tenets of Dodd-Frank requires financial advisers to act in the best interests of their clients. Repealing the law, according to proponents of Dodd-Frank like watchdog organization Better Markets, will “unleash Wall Street on Main Street, which is exactly what the financial protections of Dodd-Frank were put in place to prevent.” Without Dodd-Frank, watchdog groups believe some financial executives might make decisions that would benefit companies at the expense of consumers. And without Dodd-Frank in place, according to proponents of the law, these financial organizations won’t be held accountable for their actions.
Opponents of Dodd-Frank say that there are too many regulations in place that can harm small banks by preventing them from lending money and competing in the marketplace. The American Enterprise Institute released “The Impact of Dodd-Frank on Community Banks” to scrutinize the law’s effect on community banks. According to the report, “approximately 90 percent of respondents reported an increase in compliance costs, and most (82.9 percent) of participating banks reported that their compliance costs had increased by more than five percent.” In short, these small banks suffered from increased compliance costs.
Rep. Jeb Hensarling, a Texas Republican and chairman of the House Financial Services Committee, has proposed legislation known as the Financial Choice Act to replace Dodd-Frank. The bill would repeal and amend the executive compensation and corporate governance provisions of Dodd-Frank, reports Bloomberg. This includes actions such as the proposal to repeal the section of Dodd-Frank that requires companies to disclose the ratio of pay between CEOs and the median employees.
While the banking industry believes the Financial Choice Act is a good alternative to Dodd-Frank, critics believe the act “would repeal or significantly reduce the requirements that publicly-traded companies disclose CEO pay, allow shareholders to vote on executive compensation, and hold back incentive-based compensation in cases of fraud,” according to Fortune.
As the Financial Choice Act gets rolling in Washington, the outcome of this legislation and the overall fate of Dodd-Frank remain uncertain.