Continued vigilance on the part of regulators, investors, and other key stakeholders will be necessary to ensure a sustainable financial system

7/15/2010

The United States Senate and House of Representatives have approved landmark legislation designed to reduce the risk of another financial meltdown and protect consumers from predatory practices. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd Frank Act) establishes more rigorous oversight of the banking and investment sectors and comes nearly two years after the collapse of Bear Stearns and the bankruptcy of Lehman marked the beginning of the global financial crisis.  We are hopeful that the passage of this legislation will be an important milestone in the effort to re-establish a financial system that supports the U.S. economy, helps businesses grow, and individuals invest and save, but it certainly is not the end of that work.

The destructive practices that led to the meltdown began long before the market crash of 2008. The Dodd-Frank Act reverses decades of deregulation  that combined with what Alan Greenspan called “irrational exuberance” on the part of a broad range  of participants (including consumers, regulators, investors and companies), fostered excessive liquidity and risk taking in our financial system that brought the U.S. economy to the edge of the cliff. Though the stories do not dominate the headlines as they did two years ago, the severe dislocation caused by the financial crisis continues to this day. Home foreclosures remain at unacceptably high levels, retirement and pension funds across the country have suffered steep losses, and millions of Americans are still unemployed.

The Dodd-Frank Act is designed to establish strong consumer protection, shield taxpayers from future corporate bailouts, shine a light on the “shadow markets” by bringing derivatives trading into the open, and establish a Financial Services Oversight Council to identify risks to the financial system. Importantly, investors can look forward to an expanded role in corporate governance, including a provision that allows the Securities and Exchange Commission (SEC) to establish proxy access and a measure that gives shareholders a vote on executive compensation.

It is too early to know exactly what effect that the Dodd-Frank Act will have on the major banking and investment companies. It is likely that the big banks will have to make significant adjustments to compensate for revenue streams affected by the rules. However, the legislation does not mandate the breakup of the largest financial firms on Wall Street. Though there is broad agreement that the Dodd-Frank Act will reduce risky behavior, will strengthen capital requirements, and limit leverage, some industry watchers question whether it will ultimately prevent another financial crisis.

Calvert’s view is that the new rules are an important piece of the puzzle, but that all stakeholders, including financial firms, investors, regulators, and consumer groups have much work left to do in order to restore an accountable and responsible banking system that helps create a solid foundation for the economy. For, while the Dodd-Frank Act is a major step forward, many of the important details will not be finalized until regulations to implement the new law are established. It is critical that supporters of a more sustainable financial sector remain engaged as federal agencies adopt and implement the new rules. Once strong rules are established, agencies such as the SEC and the Treasury, and the new Consumer Protection Bureau must have the resources and authority necessary to provide effective oversight. We can be sure that banking and investment companies will continue to innovate, developing new products and services, and taking new kinds of risks. Regulators and investors must continue to ask tough questions and best practices must evolve to ensure that the potential problems of the future do not slip past defenses that were designed to protect against dangers of the past.

Calvert joined many other investors, including members of the Social Investment Forum and the Council of Institutional Investors in playing an important role in the debate over shareholder rights leading up to passage of the legislation. Now that the Act has been approved, shareholders must become more engaged with the companies they own in order to capitalize on the hard fought gains of the Dodd Frank Act. Calvert will continue to work with like-minded investors to call upon companies to manage their businesses with long term sustainable performance in mind.

The shock of the past two years vividly demonstrates the results of insufficient regulation as reflected in: irresponsible lending standards, deceptive securities practices, and executive compensation that appears to be disconnected from corporate performance.   Against this backdrop, the Dodd-Frank Act is a significant accomplishment, but again, it is the beginning, not the end of the effort to establish a more sustainable and responsible financial system.

Key measures Calvert and other investors advocated for and their status in the final bill:

Proxy Access in Corporate Board Elections:  The legislation gives the SEC authority to implement a proxy access rule.  This is an important victory for shareholders, which was only secured in the last week of the negotiations between members of the House and Senate.

Say on Pay:  The final legislation gives shareholders a say on pay, but allows companies to seek shareholder approval to hold investor advisory votes on compensation every two or even three years instead of requiring that companies offer such a vote every year. Calvert will urge companies to offer the advisory vote on an annual basis, which would help ensure that corporate boards design compensation programs that align management and investor interests.

Majority Voting:  In a significant setback for shareholders, a provision that director elections at all companies should be decided by majority votes was stripped out of the legislation.  Calvert will continue to call upon companies to establish a majority vote, which in our view is a fundamental principle of shareholder democracy.

Better Consumer Protection:  The legislation establishes a strong and independent consumer watchdog. The Consumer Financial Protection Bureau will help borrowers avoid predatory practices in a variety of financial products and services, including mortgages, pay day loans, and student loans. 

Credit Rating Agencies: Provides new rules for transparency and accountability for credit rating agencies to protect investors and businesses.
Creation of a Systemic Risk Regulator:  The Financial Services Oversight Council adds an important level of protection for the financial system, thus we can anticipate that systemic risk will continually be reviewed by the regulators.
Providing Sufficient Resources to Regulators:  While improved regulations are a positive, it is equally important that the regulatory bodies themselves be given the resources and political support to succeed at their jobs.  The SEC did not get approval for self funding. However, there are provisions that will provide it a more consistent stream of funding including for important technology upgrades.
Enhanced Regulation of Derivatives: The Act moves the most risky trading of derivatives to open and transparent markets.

 Calvert Asset Management Company, Inc., 4550 Montgomery Avenue, Bethesda, MD 20814.

To learn more about Calvert or other mutual fund companies, visit  Fund Companies.  For particular fund information, visit Fund Selector.