The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into US federal law by President Barack Obama on July 21, 2010. Making the most significant changes to financial regulations in the US since the Great Depression, the Act is an attempt to pre-empt another economic crisis.

The Bureau of Consumer Financial Protection consolidated the functions of several agencies to oversee credit reporting agencies, credit and debit cards, as well as consumer loans. It protects homeowners in real estate transactions by ensuring they understand risky mortgage loans. It also requires banks to verify the borrower’s income, credit history and job status.

The Financial Stability Oversight Council looks at risks that affect the entire financial industry, including non-banking financial firms such as hedge funds. If any of these companies get too big, it can recommend action by the Federal Reserve, which can ask it to increase its reserve requirement. This prevents another AIG-like company that’s too big to fail. In extreme cases it has power to break up financial firms.

Dodd-Frank required the riskiest derivatives, such as credit default swaps, to be regulated by the Securities and Exchange Commission or the Commodity Futures Trading Commission. Excessive risk-taking can be spotted and brought to the policymaker’s attention before any major crisis can occur. A clearing house, similar to the stock exchange, must be set up for trading these derivatives in public.

The Act created an Office of Credit Ratings at the SEC to regulate credit rating agencies, which many blame for misleading investors by over-rating certain derivatives and mortgage-backed securities. The SEC can ask agencies to submit their methodologies for review, and deregister those that give faulty ratings.

One of the reasons for the 2008 financial crisis was that hedge funds and other financial advisers were not regulated. No one knew the portfolio of these funds and the risks they took. Under the Act, hedge funds are registered with the SEC, and should provide details of their portfolios and trade so that the SEC can assess the market risk.

While the law is focused on regulating financial services, it has provisions that affect every public company, including enhanced corporate governance requirements. It creates an SEC programme to encourage reporting of securities violations. It offers rewards up to 30 per cent of funds recovered for information leading to SEC action resulting in over $1 million in sanctions. Employers are prohibited from retaliating against whistleblowers. Under the Act, whistleblowers have been awarded millions of dollars. One case involved information on a bank’s illegal encouragement of secret offshore accounts held by US taxpayers. The whistleblower was awarded approximately $104 million.

The Act calls for enhanced compensation disclosures. The SEC has statutory authority to clarify disclosure rules related to compensation, including a chart that compares executive compensation with stock performance over a five-year period. Companies should disclose in their annual proxy statement the median of annual compensation of all employees other than the CEO; the annual compensation of the CEO; and the ratio of these two amounts.

Issuers should implement a ‘clawback’ policy to recover incentive-based compensation from current or former executives during a three-year look-back period. The policy would apply if the company issues an accounting restatement based on erroneous data due to material non-compliance with financial reporting requirements under the securities law, regardless of whether or not the executive was involved in the misconduct that led to the restatement. Companies should also disclose their incentive-based compensation policies. These requirements expand on the existing clawback provision in the Sarbanes-Oxley Act.

The SEC can prohibit a broker that is not the beneficial owner of a company’s shares (that is, shares held on behalf of retail investors) from voting on the election of board members, executive compensation or other significant matters, unless the beneficial owner has given the broker voting instructions.

SEC can act against persons who recklessly aid and abet violations of the securities law (previously the law required ‘knowing’ violations). The Act defines the jurisdiction of US courts over antifraud cases brought by the SEC or the Department of Justice where much of the activity occurs outside the US. This had previously been a matter of case law. The law sets the standard such that US jurisdiction in these types of cases exists if “significant steps in furtherance of the violation” are taken in the US.

The author is Partner in a member firm of EY Global

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