What Does Financial Reform Really Mean for the Board?

By Philip K. Smith, Gerrish McCreary Smith, PC

Financial reform is here! While Congress would lead us to believe that financial reform is something we should all be excited about, few bankers or bank directors really see it that way. However, it continues to be the job of the board to lead in difficult times and that includes understanding the implications of this landmark legislation and fitting the board and the organization into its proper place in operating under the new guidelines. 

The new piece of legislation is known in some circles as the Dodd-Frank Act. However, you will notice in other news outlets, particularly those focused on community banking, that it is being referred to as the Wall Street Reform Act. As board members in discussing the overall Reform Act’s impact and in setting its proper tone for your organization, it might be appropriate to continue to remind your stockholders and consumers that the legislation was not intended to reform community bank practices, but really to take aim at Wall Street abuses. 

One of the things that board members need to be concerned about is increasing costs associated with compliance with the new legislation. Particularly, the establishment of the Consumer Financial Protection Bureau as part of the legislation could ultimately result in new consumer regulations that have a disproportionate impact on community banks. 

In the final legislation, banks with less than $10 billion in assets are exempt from primary examination and enforcement by the Consumer Financial Protection Bureau. While that sounds like a victory for most of us, we caution board members in leading their organizations not to assume that consumer protection will not also continue to be a focus for their institutions. 

While institutions with less than $10 billion in assets are not subject to direct examination by the CFPB, small institutions are still subject to new rules and regulations that are developed and demands for data and certain disclosures. In addition, the Bureau, if it so chooses, could elect to jointly participate in an examination of a community bank. 

One area where small public companies will benefit is that those public companies with capitalization of less than $75 million are permanently exempted from the auditor attestation requirements of the Sarbanes-Oxley Act which threatened to dramatically drive up costs for small institutions. For those institutions that are not public, the Sarbanes-Oxley Act has never been applicable anyway. 

Under the new legislation, publicly traded holding companies that have more than $10 billion in assets are required to establish Risk Committees with independent directors. This sounds exactly like the type of mandate for large institutions that the regulators may find to be a “best practice” for even the smallest institutions. Therefore, the board should continue to focus the board and management on risk compliance and may begin looking at establishing a separate Risk Committee. 

There has been quite a bit of talk about whether or not organizations, particularly small organizations, could continue to utilize or count existing trust preferred securities as tier 1 capital. For most community bank holding companies (those with less than $15 billion in total assets), there is good news in that all trust preferred securities issued prior to May 19, 2010 are grandfathered and can continue to be counted as tier 1 capital at the holding company level for those institutions that do not meet the small bank holding company definition (institutions less than $500 million in total assets). For institutions that are less than $500 million in total assets, it is the bank level capital that is important, so those institutions can continue to use trust preferred securities as a way of generating cash at the holding company to contribute to the bank as tier 1 capital, notwithstanding anything in the new regulation. 

In terms of capital raising, one technical issue the board should be aware of also is the change in the definition of who is an “accredited investor”. The change in the definition, which now excludes the principal residence from overall net worth requirements, may make it more difficult to raise capital in a closely held bank, or at least make it a bit more expensive. 

One of the provisions of the new legislation that hasn’t received much attention is the elimination of restrictions on interstate branching. In essence, if a bank in the state of Washington wants to open up a brand new branch in the state of Florida, it can now do so without regard to restrictions for acquiring a whole bank in the state. This may open up expansion opportunities for those institutions that geographically lie close to other state borders, but have been prohibited by outdated state law on branching across state lines. 

The new financial legislation is certainly going to change the way we all operate. However the extent to how we will all be impacted is yet to be determined, since much of the teeth from the legislation will come from implementing regulations by the agencies. However, if nothing else, we have guaranteed that things have changed. Is your board ready? 

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