Failure of the Dodd-Frank Act
| DOI | https://doi.org/10.1108/JFC-11-2014-0053 |
| Date | 05 October 2015 |
| Published date | 05 October 2015 |
| Pages | 520-572 |
| Author | Michael I.C. Nwogugu |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial crime |
Failure of the Dodd-Frank Act
Michael I.C. Nwogugu
Independent Researcher, Newark, New Jersey, USA
Abstract
Purpose – This paper aims to explain the weaknesses and inconsistencies inherent in the Dodd-Frank
Act of 2010 (USA).
Design/methodology/approach – The approach is entirely theoretical and multi-disciplinary (and
relies on some third-party empirical research), and it consists of a literature review, critique and the
development of theories which are applicable across countries.
Findings – The Dodd-Frank Act is inefcient and inadequate as a response to the global nancial
crisis. The Dodd-Frank Act has not resulted in signicant economic growth and has increased
transaction costs and compliance costs for both government agencies and nancial services companies.
Originality/value – The author developed the theories introduced in the paper.
Keywords Global nancial crisis, Dodd-Frank Act, Financial regulation
Paper type Research paper
Introduction
In July 2010, the US Congress enacted the Restoring American Financial Stability Act of
2010 (“RAFSA” or the “Dodd-Frank Act”)[1], which consists of several individual
distinct statutes. RAFSA substantially changes the nature and effects of federalism and
preemption in the USA – RAFSA grants more powers to the federal government to
regulate more nancial services, but because the statute leaves critical details up to the
US Securities and Exchange Commission (SEC) and the US Federal Reserve System,
sections of RAFSA may be challenged in court on constitutional grounds as void for
vagueness.
RAFSA has affected and is likely to continue to affect legislation and adjudication in
many countries because many such countries’ constitutions are based on the US
Constitution (and were either enacted or amended within the past 20 years). RAFSA
may also be relevant to Commonwealth Countries because like the USA, their legal
systems and constitutional principles are based on the British legal system. The
governments and citizens of the United Kingdom, Canada, India and other
Commonwealth countries have signicant investments in the USA, and US commercial
and investment banks (which are subject to RAFSA) are very active in the UK capital
markets and in many Commonwealth countries. The shares of many companies based
in Commonwealth countries are listed in the USA. The global nancial crisis of
2007-2014 affected many Commonwealth Countries (like the United Kingdom, India,
Canada, Australia, etc.).
Existing literature
According to Polk (2013b), as of the beginning of July 2013, 279 RAFSA rule-making
requirement deadlines had passed. Of these 279 passed deadlines, 175 (62.7 per cent)
have been missed and 104 (37.3 per cent) have been met with nalized rules. In addition,
The current issue and full text archive of this journal is available on Emerald Insight at:
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DOI 10.1108/JFC-11-2014-0053
155 (38.9 per cent) of the 398 total required rulemakings have been nalized, while 127
(31.9 per cent) rulemaking requirements have not yet been proposed.
Some authors have criticized RAFSA and noted the following weaknesses:
• RAFSA does not eliminate the too-big-to-fail phenomenon (Natter, 2011;Noss and
Sowerbutts, 2012;Li et al., 2011a;Otker-Robe et al., 2011;Brewer and Jagtiani,
2013;Schmid, 2012;Fisher, 2013) and does not help to reduce systemic risk
signicantly[2] (given that the global nancial crisis was caused by “universal
banks” who incurred more than US$8 trillion of operating losses between 2007
and 2012, allowing large banks to remain large is probably error; Wilmarth, 2009).
• RAFSA increases transaction costs and compliance costs[3].
• RAFSA effectively grants excessive power to the US Federal Reserve[4].
• RAFSA did not make the US SEC a self-funded agency, and this limits the SEC’s
scope and powers[5].
• USA Congress can still limit RAFSA by underfunding it (Carton, 2011).
• RAFSA has not created any meaningful economic growth in the USA[6].
• RAFSA did not remedy the inefciencies in executive compensation in nancial
services companies and Systemically Important Financial Institutions (SIFIs)[7].
• RAFSA omitted some key legislation[8].
• The orderly Liquidation Authority is inefcient[9].
• RAFSA makes it difcult for small companies to raise capital[10].
• RAFSA does not adequately address the members of the boards of directors’
(BOD) obligations that pertain to risk management (Johnson, 2011).
• RAFSA is inefcient[11](Gordon and Muller, 2011;Peirce and Broughel, 2012).
• Transparency and potentially harmful disclosure (Nazreth and Tahyar, 2011)–
RAFSA created an intolerable level of uncertainty as to whether information that
nancial services companies disclose to government agencies will be kept
condential.
Greene (2011) noted some of the problems inherent in RAFSA such as the following:
• failure to deal with regulatory fragmentation which refers to having too many
government agencies – however, Greene was not specic and did not state
which government agencies should have been combined, restructured or
eliminated;
• failure to address international coordination – regulatory arbitrage remains
an issue, and funding resolution and bailout expenditures have been a point of
international divergence; and there is also a serious question about whether
Dodd-Frank will undermine the competitive position of major US nancial
institutions because some sections of Dodd-Frank Act such as the Volcker
Rule will not be followed in other key jurisdictions such as the European
Union;
• being overly optimistic in dealing with too-big-to-fail;
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• it does not restrict size by growth, only by acquisition (but the ve largest US
nancial institutions have grown 20 per cent since the onset of the global
nancial crisis, and as of 2011, they had over US$6 trillion in assets);
• it implies that size is not necessarily the only concern but size can be critical,
because of the contagion effect of failure;
• the Swiss approach to regulation is based on the theory that capital
assessment and organizational simplicity are the solution, not activity
restriction or size limitations – RAFSA takes almost an opposite approach;
and
• RAFSA does not address the issue of moral hazard adequately – and despite
the many provisions to monitor and reduce systemic risk, it remains unlikely
that the US Government will allow an institution that is the size of one of the
US’s ve largest nancial institutions to fail, especially in the absence of
effective coordinated and consistent resolution mechanisms in key markets
(and such rms will continue to have nancing advantages that only increase
the likelihood of their failure).
Hansberry (2012) noted that RAFSA distorted the Foreign Corrupt Practices Act. Coffee
(2012b) reviewed various reasons why RAFSA has failed, including moral hazard,
executive compensation, excessive focus on the too-big-to-fail dilemma and cognitive
decits. The Economist (2012),Simon (2012),Morrison and Foerster (2012) and Gray and
Shu (2010) stated that RAFSA may be unconstitutional but for reasons different from
those stated in Nwogugu (2010/2014).Heritage Foundation and National Association of
Criminal Defense Lawyers (NACDL) (2010a,2010b[12], 2010c) and Joslyn (2010)[13]
have questioned the effectiveness and validity of the criminal law provisions in RAFSA.
American Action Forum (2010) and Elliot (2010) questioned the extent of regulations of
both the size of banks and trading of derivatives (two critical issues that led to the global
nancial crisis). Schwarcz (2011) critiqued RAFSA’s ability to reduce systemic risk.
Rose and Walker (2012)[14] noted the lack of adequate cost-benet analysis for statutes
like RAFSA.
Roe (2013) attempted to analyze the problems inherent in central clearing houses
(“CCHs”) within the context of RAFSA, but the following are the errors and omissions in
the Roe’s (2013) study:
(1) The analysis of set-off is almost irrelevant in this context because of the
following reasons:
• in the USA, the application of set off varies across different US bankruptcy
courts (there has not been consistency) and US bankruptcy courts have broad
discretion to grant or deny set-off[15](Caughey, 2011), and to rescind set-offs
that occur within the 90-day period immediately before the ling of
bankruptcy;
• in the USA, the applicability of set-off varies according to state law (some
states have a common-law right of set-off), particularly in cases or
circumstances where state law is deemed to preempt sections of the US
Bankruptcy Code;
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