Alert February 03, 2009

Congressional Oversight Panel Issues Special Report on Regulatory Reform

The Congressional Oversight Panel (“COP”), which was created pursuant to the Emergency Economic Stabilization Act of 2008 to oversee the Treasury’s Troubled Asset Relief Program and review the current state of financial markets and the regulatory system, released a Special Report on Regulatory Reform (the “COP Report”) in which it analyzed the current financial crisis and made recommendations for the future.  The COP Report identified eight specific areas most urgently in need of reform:

  1. Identify and regulate financial institutions that pose systemic risk, including nonbank financial institutions, by creating a systemic regulator (either an existing agency or a new agency), imposing heightened regulatory requirements for systemically significant institutions, and establishing receivership and liquidation processes for systemically significant nonbank institutions which are similar to the system for banks.

  2. Limit excessive leverage in American financial institutions through enhanced capital requirements.

  3. Increase supervision of the “shadow financial system” of unregulated financial instruments such as over-the-counter derivatives, off-balance sheet entities such as conduits and nonbank financial institutions such as hedge funds and private equity funds.

  4. Create a new system for federal and state regulation of mortgages and other consumer credit products through the elimination of federal pre-emption of state consumer protection laws for national banks and the creation of a single federal regulator for consumer credit products.

  5. Create executive pay structures that discourage excessive risk taking through tax incentives which encourage long-term oriented pay packages, regulation of risk-rewarding compensation structures, “clawbacks” of bonus compensation and increased board oversight.

  6. Reform the credit rating system by addressing conflicts of interest and creating a Credit Rating Review Board.

  7. Make establishing a global financial regulatory floor a U.S. diplomatic priority.

  8. Plan for the next crisis through the creation of a Financial Risk Crisis Council of outside financial experts.

The COP Report also identified three areas that the relevant regulatory agencies should review: accounting rules, securitization, and short-selling.  The COP Report will be a key factor as Congress and the new administration weigh broad changes to the U.S. financial system.  The COP stated that it plans to address regulatory architecture more thoroughly in a subsequent report, including the issues of co-regulation, universal banking, regulatory capture, the revolving door problem, bankruptcy and receivership issues involving financial institutions, and the division of regulatory responsibilities.