Top 10 Things You Need to Know About Dodd-Frank

Signed into law by President Obama last July, the Dodd-Frank Wall Street Reform and Consumer Protection Act is over 2,300 pages long and contains provisions relevant not just to financial firms, but to investors and borrowers. While many of the bill’s instructions have yet to be made specific—and with the GOP takeover of the House, you can expect pitched battles about these provisions in the months to come—here’s what we know now about how Dodd-Frank will affect you.

1. The definition of “accredited investor” will change.

To partake in certain types of investments, such as limited partnerships and hedge funds, investors have to meet the legal definition of an “accredited investor.” Before Dodd-Frank, that meant a net worth of $1 million or a $200,000 salary three years running. Dodd-Frank raises this bar. Now the value of an investor’s primary home is removed from the net worth calculation, which tightens the definition considerably. Investors who don’t make the cut can’t participate in some investments and may have to divest them.

 

2. Privileged investors will lose access to banks’ in-house investment funds.

Dodd-Frank’s Volcker Rule will generally, though not entirely, prohibit banks from investing in hedge funds and private equity funds with their own money. Previously, big banks would open those internal funds to some of their wealthier individual clients. Now, not only will such funds largely disappear, but banks risk losing skilled fund managers. “You’re going to see a lot of people who managed these funds hanging out their shingle,” says Steven Braverman, co-founder of Pathstone Family Office. That may prompt individual investors to reconsider their relationships with those banks or adjust their investments.

3. New restrictions on foreign advisors and hedge fund managers.

Some foreign advisors and many hedge fund managers who previously flew under the radar will now have to register with the SEC or reduce services to U.S. clients and investors. For better or worse, those who do register may incur higher costs, more red tape and closer scrutiny. “High net worth investors could see reduced investment opportunities in these areas and higher costs,” says Stacee Hasenbalg, chief trust counsel, Harris Private Bank.

4. New decisions for high net worth families who work with family offices.

Dodd-Frank eliminates the private advisor exemption from the Investment Advisors Act of 1940 for advisors with fewer than 15 clients, which is the exemption that many family offices have long used to avoid registering with the SEC. Though the act now exempts family offices, that term has yet to be defined, and the extent to which the exemption will include multi-family offices is also unclear. High net worth families will now have to make decisions about whether to register their family office, create a private trust company (which requires a significant start-up investment of capital and expertise), or engage a financial firm that already works within a regulatory structure.

5. Possible new restrictions on broker/dealers.

Investment advisors have long been seen as fiduciaries for their clients and consequently are held to “a high standard of care,” according to Arthur Don, a partner in the corporate and securities practice at Greenberg Traurig. Broker/dealers have had to meet only a “suitability” standard, which generally means that a security purchased for a client must meet the client’s needs and investment experience. Nonetheless, they increasingly try to serve and charge their clients in a way similar to that of investment advisors. Dodd-Frank asks the SEC to decide whether broker/dealers should be held to the same legal standards as investment advisors. If that happens, either many brokers will change their client services and practices, or they’ll register as investment advisors and charge clients an asset-based, rather than service-based, fee.

6. Tougher rules regarding the safeguarding of investor assets.

Dodd-Frank maintains the SEC’s authority to issue rules regarding the safeguarding of client assets deemed to be in the custody of an investment advisor. That’s important because, in March 2010, the SEC adopted new amendments to the Investment Advisers Act that subject some investment advisors with custody to independent audits. These rules may also permit the SEC to contact affiliates of the advisor to obtain information about high net worth families, their trusts, other entities and family investments held at those affiliates.

7. The SEC will have more access to client information.

Effective one year after its passage, Dodd-Frank broadens the rules surrounding disclosure of confidential client information held by an investment advisor. Now, confidential information is protected from disclosure to the SEC, except when necessary or appropriate in a specific proceeding or investigation. Under Dodd-Frank, the SEC may also require investment advisors to disclose the identity, investments or affairs of any client “for purposes of assessment to potential systemic risk.” While some banks have warned of privacy incursions, the real reason is pro-investor: To ensure that investors’ money is where their advisor says it is, and that they aren’t being ripped off by the next Bernie Madoff.

8. New requirements for registered investment advisors to private funds.

Dodd-Frank imposes additional obligations on registered investment advisors to private funds exempt from registration under the Investment Company Act of 1940. Advisors to these funds will be subject to new reporting, examination and disclosure requirements, which should mean both greater costs to and more security for investors. There are exceptions: Advisors who deal exclusively with “venture capital funds,” to be defined by the SEC within one year, are exempt from registration, for example.

9. Members of corporate boards will have added responsibilities.

Dodd-Frank’s “say on pay” provision will permit public company shareholders to cast a yes or no vote on executive compensation. Company directors don’t have to adhere to this vote, but would be foolish not to take it as a warning, explains Andrew Liazos, who leads the executive compensation practice at McDermott Will & Emery. “The SEC sees compensation as an indicator of the relationship between the board and CEO—does it have the backbone to stand up to him?” asks Liazos. Corporate board members, especially those on compensation committees, will have to ensure that they’re up to speed on how the company is performing and how its executives are paid relative to comparable peers.

10. Investors will have a larger voice in sec rules and regulations.

Dodd-Frank has created an Investor Advocate’s Office to assist investors with problems it has with the SEC itself. The office has the power to establish an ombudsman to serve as a liaison between investors and the SEC’s investment advisory committee. “The rules for how this will all work remain to be seen,” says Greenberg Traurig’s Arthur Don. But, he points out, the securities industry is a vigorous lobbyist, and this office should give investors a channel for their own input on regulatory rules and policy matters.

 

Curator