Financial Planning for August, 2010

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Wall Street Reform Reveals Complex Nature of Regulation

With the July enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the financial reform debate moves from Pennsylvania Avenue to the offices of the regulators. Although the Act establishes a new regulatory environment for the nation's financial system, the immense task of reforming it will require a great deal of planning.

Let's take a look at some of the provisions that are likely to affect you.

Depository Insurance

Perhaps the most important provision for bank customers is the permanent extension of the $250,000 FDIC insurance limit. The limit increase has been made retroactive to all bank failures during 2008. Accordingly, some 9,500 depositors who did not fully recover their funds from banks failing before October 3, 2008, will now be eligible to fully recover all claims. In most instances, the FDIC has already mailed the additional funds due depositors; however, if you need more information on this subject, go to the FDIC website.

Investor Protection

The Act requires regulators to conduct numerous studies as precursors to new regulations. Among the issues requiring study is the imposition of a fiduciary relationship between brokers and clients. Presently, brokers are only required to recommend suitable investments to their clients. Imposing a fiduciary relationship will require the broker to recommend investments that are in the client's best interest - not the broker's best interest. The Securities Exchange Commission, which regulates brokers, is required to conduct a study on the cost-benefit of enhancing the advisory relationship between brokers and their clients.

Derivatives, hedge funds and swaps are among the villains of the financial turmoil in recent years. The Act provides significant new additional registration requirements for advisors dealing in these funds, and for the funds themselves.

Of significance to many 401(k) investors is the Act's potential effect on Stable Value Contracts. To most investors in retirement funds, a Stable Value Contract is essentially equivalent to a guaranteed investment contract. Inclusion of these investments in the definition of a swap could have a significant negative effect on the investor's return. Regulators, in connection with the Department of Labor, the United States Treasury and state regulators, are required to study the advisability of including such contracts in the definition of a swap (and to make their recommendation within 15 months of the enactment of the Act). Contracts in effect prior to the issuance of any new regulations will not be considered swaps.

Mortgage backed securities, asset backed securities and other debt instruments have received significant negative attention in recent years. Credit rating agencies play a significant role in both the issuance and subsequent trading of these securities. Included in the Act is the requirement that credit raters be considered experts in the securities registration process, much the same as auditors, and that their credit ratings be included in registration documents. This heightening of the agencies' liability exposure means that many bond issues were held up until after the effective date of the Act because agencies refused to allow their ratings to be included in registration documents. At present, the SEC has allowed the bond issues to move forward without the ratings included. This turn of events serves as a reminder of the immense complexity of implementing the Act.

The much anticipated Bureau of Consumer Financial Protection will be added as a new function of the Federal Reserve Bank. It will have authority over financial institutions that offer financial products and services to consumers. It will not have authority to examine or issue regulations over insured depository institutions and credit unions with assets of $10 billion or less.

Parting Thoughts

Changes are in the wind for the U.S. financial system. While the Act already is exhibiting significant effects on the markets, the full impact of the Act will not be known for several years. One thing, however, is certain: the way business is done in the U.S. financial system will change significantly in the years to come.

Have a terrific month.


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