2010

Dodd-Frank Financial Regulation Law

Research Paper Honor Level
Discussion over the influence of the law on hedge funds management and Securities and Exchange Commission operation

Linh Dao
Honor FIN 331 Dr. Jean Snavely, Ph.D 12/10/2010

Linh Dao Fin 331 Honor Paper

On Thursday, July 15, 2010, the final approval was made by Congress for the most potential and ambitious financial regulation in generations which signals a positive direction in recovering the economic condition after the crisis. In detail, President Barack Obama has signed the most sweeping set of financial laws since the Great Depression of 1930s to show how the rules and regulation will be put into effect. During the bill-signing ceremony at the Ronald Reagan building in downtown Washington, Obama emphasized the significance of the reform: It is designed to make sure that everyone follows the same set of rules, so that firms compete on price and quality, not tricks and traps. Apparently, protection on customer benefits and fair competition between companies are expected to be the key point of the newly approval law. Along with this success, great hope on substantial recovery of the United States economy after the 2008 financial crisis appears reasonable. The Financial Regulation (FinReg), once approved, is named after its principal authors, the Dodd-Frank Act. As I noticed, there has been a tradition that the chief sponsors name in the House always comes after the chief sponsor in the Senate; in this case, Connecticut Senator Christopher Dodd precedes the Massachusetts Representative Barney Frank. Under the new regulation, the vast market for derivatives, complex financial instruments that fueled the crisis, will be subject to government oversight and control1. According to the Chamber of Commerce, the law calls for 533 rules, 60 studies and 95 reports of which the regulators will be in charge. In another word, the strongest consumer financial protections in history will bring an end to taxpayer bailouts, with adjustments to the regulation made along the way2. In order to achieve the ultimate purposes, the legislation is in the process
1

Brady, Dennis. "Congress passes financial reform bill." (2010) Mattingl y, P hil. "Financial Overhaul is Law, Now C omes Battle Over its Rules." (2010)
2

Mattingl y, P hil. "Financial Overhaul is Law, Now C omes Battle Over its Rules." (2010)
[Type text]

Linh Dao Fin 331 Honor Paper

of establishing an independent bureau within the Federal Reserve with the authority providing American consumers with the most precise and accurate information regarding mortgages, credit cards or other financial type of lending, and to eliminate hidden fees, abusive terms and deceptive practices. Among the adjustments being put into effect, the changes in hedge fund registration and operation are considered substantial. There are multiple standpoints on whether these major reforms, to some extent, would benefit or restrict investors. Hedge funds requires a large pool of capital; therefore they are basically mutual funds for super wealthy investors who are substantially knowledgeable about investment. There has been no restriction on how much to invest as well as how profits will be distributed3 .As the law fills regulatory gaps which now requires hedge funds and private equity advisors to register with the Securities and Exchange Commission and provide information about their trades to measure systematic risk, sooner or later hedge funds will be regulated under SEC. Consequently, investors may no longer be able to use arbitrage or short sell the investments; managers may no longer participate in the profit of the fund to manage the interest of investors. Furthermore, the Dodd-Frank financial overhaul law may restrict commercial banks in trading speculative investments or at least in setting an investment maximum limit of three percent of their capital4. This is the direct result of adopting the Obama administrations Volcker Rule that requires regulators to implement regulations for banks and their affiliates to forbid proprietary trading and sponsorship of hedge funds, and to limit relationships with hedge funds

Herszenhorn, David. "Bank Fee Is Eliminated in Financial Bill." (June 29th 2010)
4

Staff and Wires. "House Passes Financial Overhaul Bill." (2010)

[Type text]

Linh Dao Fin 331 Honor Paper

and private equity funds. In my opinion, these attempts to standardize hedge funds may not be appropriate. It is the fact that hedge funds are created to provide a small number of wealthy investors with a type of investment that exposes the great possibility of spectacular high rate of return and the substantial amount of risk associated known as the hedge risk. The limit of 3 percent would certainly realocate hedge risk into the controllable range and, unfortunately, also the rate of return. The term spectacular would be invalid in the context that investors expected returns which far exceed the allowed actual rate could not be reached. That means the primary purpose of tying high risk and high return in hedge funds investing strategy no longer exists. Thus, investors find it disadvantageous to completely benefit from abnormal volatility with substantially high return and to offset future market downturn. The drawback, especially in multi-billion hedge funds scenario, would result in enormous differences. However, optimistic investors should regard the restriction a good way to eliminate a certain amount of excessive hedge risk in pursuing highly volatile investments. In this case, the law may succeed in protecting investors from critical losses which would likely to happen anytime. In general, it depends on the investors themselves to consider these changes regarding hedge funds as advantages or disadvantages. According to the legislation, the SEC is expected to play a more active role in monitoring market activities and ensuring investors benefits. Being granted with significant rights and authorities, the SECs intention will be focusing on preventing deceptive practices and acting on the best interest of investors. In order to approach these ultimate goals, in my opinion, the transparency and accountability for exotic instruments would draw the most attention. Thus, the SEC should concentrate on eliminating loopholes that allow abusive and risky practices to continue unregulated and unnoticed in certain areas: over-the-counter derivatives, asset-backed
[Type text]

Linh Dao Fin 331 Honor Paper

securities, mortgage brokers, payday lenders and especially, hedge funds. Whistleblowers are also encouraged to report investing violations and recover up to 30% of funds as rewards. Ultimately, the ideas of fair trading games and equal investors benefits will be strongly supported. Although the process of elimination consumes a considerable amount of time and efforts, SECs attempts to monitor and develop a more efficient market will effectively strengthen the market activities and market enhancement, especially in the current economic condition after crisis. Furthermore, a committee of investors called the Investment Advisory Committee is established primarily to consult with the SEC about its regulatory authorities and practices. Keeping the interest of investors in mind, the Committee acts as a problem-solving agency which deals with conflicts and complaints originated between investors and the SEC. Thus, the idea of investors protection will be well supported. On the other hand, the law requires certain forms of public disclosure to the SEC of cash flows and money payments. Most of the firms, especially which engaged in commercial development of oil, natural gas or minerals are required to report their payments and subsidiaries made to foreign government. That information should be posted online for the purposes of investors publicly official access. In my opinion, this approach is regarded as the most timely SECs response to the global problem associated with foreign bribery and illegal outsourcing which have attracted public attention for a long time period. Along with constant investigation of pharmaceutical firms recently, the US governments as well as the SEC are showing their endeavors in order to ensure legal globalizing activities and maintain the appropriate level of competition between firms the key feature of an efficient market. Moreover, legislators establish a so-called Office of Credit Rating at the SEC in order to provide adequate rating and
[Type text]

Linh Dao Fin 331 Honor Paper

examine the Nationally Recognized Statistical Rating Organizations at least once a year. The office acquires the ability to deregister any agencies which provide poor rating mechanism for certain periods of time. Ultimately, the most accurate and appropriate information which greatly benefit the majority of investors will be guaranteed. The Dodd-Frank Act played a significant role in reforming the economic system and implementing several approaches. By concentrating on the protection of investors, the law is enforced in order to eliminate loopholes that result in abusive and deceptive practices in the market and to maintain the benefits of shareholder and investors. Among these amendments, several major changes in hedge funds management and SEC operation attract most of the public attention due to their critical and decisive changes. Questions regarding whether these adjustments are useful or inappropriate really depend on individual point of view. It is the fact that financial regulation is a time-consuming process; therefore the governments, to some extent, have succeeded in making a higher efficient and profitable market approachable.

[Type text]

Linh Dao Fin 331 Honor Paper

B i b l io g ra p hy
Dodd, C hristopher and Frank, Barne y. United States. Dodd -Frank W all Street Reform and Consumer Protection Act . Washington: , 2010. Print. Mattingl y, P hil. "Financial Overhaul is Law, Now C omes Battle Over its Rules." (2010): 2. pag. Web. 11 Dec 2010. <http://www.bloomberg.com/news/2010 -07-21/obama-signs-biggestoverhaul-of-financial-rules-since-the-great-depression.html>. Staff and Wires. "House Passes Financial Overhaul Bill." (2010): 1. pag. Web. 11 Dec 2010. <http://www.npr.org/templates/stor y/stor y.php? stor yId = 128225065>. Brady, Dennis. "Congress passes financial reform bill." (2010): 3. Web. 11 Dec 2010. <http://www.washingtonpost.com/wp d yn/content/article/2010/07/15/AR2010071500464.html> Herszenhorn, David. "Bank Fee Is Eliminated in Financial Bill." (June 29th 2010): 1. Web. 11 Dec 2010. <http://www.n ytimes.com/2010/06/30/business/30regulate.html>.

[Type text]