Dodd-Frank 15 years later: How financial regulators leveled up

The leadup to Dodd-Frank

This month marks the 15th anniversary of the Dodd-Frank Wall Street Reform Act. This law was enacted in the wake of the 2008 financial crisis. Despite often being framed as a time of lax and insufficient government regulation, the leadup to the Great Recession was paved, in part, by heightened regulation of US banks. We saw this with the undue meddling by government-sponsored enterprises Fannie Mae and Freddie Mac in addition to the provisions of the Community Reinvestment Act, which exacerbated bank losses. As my CEI colleague John Berlau reminds us:

Fannie bought billions in commercial mortgage-backed securities from Lehman, and the two firms were also counterparties on derivatives contracts worth billions. As for Freddie, a March 2013 FHFA Inspector General report found that that the two firms ‘had extensive business relations. Lehman sold mortgages to Freddie Mac and also served as one of Freddie Mac’s investment bankers.’

This fostered a market for pooling subprime mortgages with other assets, while riding high on the housing bubble between 2000-2008 until it eventually burst. The ensuing decline in home values led many borrowers to default on their mortgages.

Dodd-Frank wasn’t created in a void of under-regulation, rather it morphed from the accumulation of new regulatory restraints on bank conduct. My recent book review of Financing Opportunity (2024), by Norbert Michel and Jennifer Schulp, explains this in greater detail. The major regulatory changes, such as heightened capital requirements, in the decades leading up to the 2008 financial crisis that actually gave regulators more authority to, as Michel and Schulp explain, “tell financial firms what they can do and how they can do it.” The regulatory enhancements that financial agencies gained and continue to deploy in the wake of Dodd-Frank’s passage have been to the detriment of Main Street businesses, entrepreneurs, and consumers

How Dodd-Frank enhanced the SEC’s powers

Dodd-Frank provided a series of administrative power boosts to financial regulators overseeing investors and banks. One of the most notable of these is the Securities and Exchange Commission’s (SEC) modified authority to issue civil monetary penalties.

Before Dodd-Frank, the SEC could impose monetary penalties on unregistered investment advisers only via a federal court order. Even today, the largest subset of monetary sanctions enforced by the SEC tend to be over registration errors for advisers and professionals that run public companies.

However, once Dodd-Frank was passed in 2010, the law empowered the SEC to adjudicate its monetary sanctions within its own in-house tribunal. This meant that the SEC’s Division of Enforcement could investigate suspected wrongdoing, gain permission from the SEC commissioners to pursue enforcement actions (including monetary penalties), and process these penalties before one of the agency’s hand-picked administrative law judges.

The SEC approved an average of 92 percent of its in-house adjudications, according to several estimates. This demonstrates how Dodd-Frank unduly empowered the agency to become a unitary judge, jury, and enforcer over securities fraud.

Thankfully, the Supreme Court’s recent opinion in SEC v. Jarkesy (2024) put an end to this unfair process, now requiring that the SEC pursue its monetary sanctions before a federal Article III court. The Court properly recognized that the financial fraud which George Jarkesy was accused of was no different than what the framers of the Constitution would have recognized during the founding era. As such, these monetary penalties affect private rights and must be brought before a court of law prior to any relief being sought.

Another advantage that the SEC gained following Dodd-Frank came with the practice of follow-on enforcement. Follow-on enforcement enables the SEC to prosecute a person twice within its tribunal.

The first case covers alleged crimes of financial fraud or similar wrongdoing. The second case (if granted) is based on a recommendation by the prosecutors to further penalize the party charged by imposing a permanent bar on their ability to work in the securities industry. Prosecutors claim that follow-on enforcements serve the public interest when the SEC charges people twice, preventing them from re-offending.

While Dodd-Frank didn’t directly introduce follow-on enforcement, the Act inspired Congress to amend the federal code to entrust the SEC with this power two years afterward.

How Dodd-Frank created and insulated the CFPB

The Consumer Financial Protection Bureau (CFPB) was perhaps the most consequential product of Dodd-Frank. Established in the wake of the Great Recession, the CFPB was intended by Congress to monitor consumer financial transactions, prevent deceptive practices, and crack down on consumer lending fraud.

However, the CFPB has veered far from its intended purpose by using its enforcement authority to punish disfavored businesses and harass financial professionals with invasive regulations. The Bureau has also been caught censoring individuals for otherwise permissible free speech.

Through Dodd-Frank, the CFPB became one of over 40 agencies to possess an in-house tribunal. Under Section 1053 of Dodd-Frank, the CFPB adjudicates enforcement actions brought by its attorneys against a host of financial institutions, such as banks, credit unions, and mortgage lenders. The CFPB’s authority to pursue enforcement actions against market actors derives from title X of Dodd-Frank.

With the above in mind, it becomes clear that this 2,300-page behemoth known as Dodd-Frank is responsible for many of the perceived ills in financial regulation.

Conclusion

Dodd-Frank passed during a period of desperation in Washington, as lawmakers scrambled to address the mortgage meltdown and ensuing recession. Because lawmakers failed to properly consider the law’s long-term consequences, Dodd-Frank is littered with problematic provisions.

Many of these provisions provided undue power to financial regulators like the SEC and CFPB at the expense of America’s financial institutions. Notable court cases like Seilia Law v. CFPB (2020), CFPB v. Community Financial Services Association of America (2024), and SEC v. Jarkesy (2024) demonstrate the dire consequences of Dodd-Frank’s unconstitutional regulatory framework.

Does Dodd-Frank award too much power to financial regulators like the SEC and CFPB in light of recent and ongoing controversies? Many Republicans rightfully condemned Dodd-Frank at the time of its passage, pointing out how it burdened banks with restrictive capital requirements and restrictions that stifled investment growth. Many have also speculated that Dodd-Frank has reduced Main Street investors’ access to capital and credit. As discussed above, we will likely find many provisions of this legislation are in serious need of repeal and reform.