2010-07-23 Financial Reform Opportunities in a Changing Financial Marketplace

The much discussed Financial Reform bill has recently been signed, ushering in a new era of regulation in the financial industry. The bill, at its root, seeks to stop the more pernicious instruments and practices that, at least in part, have led the national economy to its current state. The steps prescribed within the legislation reflect a nation eager to not only insulate itself from further economic harm, but to learn, observe and understand American financial systems on a more intimate and probing level. The goal then is not to constrict financial activity, but to “promote the financial stability of the United States.”

Nevertheless, the reforms will require that both the banker and regulator have access to a broad range of information previously unbeknownst to them, putting the technologies that facilitate such an exchange of knowledge in high demand. Opportunities are many for strategic growth and sound investment within the financial compliance software industry, as demonstrated by Fidelity Information Services, Inc.’s recently announced acquisition of Compliance Coach, a provider of software tools for compliance with applicable laws and regulations. The legislation also affords both newly created and existing governmental organizations more funding, which they may utilize to acquire technologies to more effectively carry out their various roles.

It is important to remember that the legislation will directly affect any company whose revenue is based primarily on “activities that are financial in nature.” The legislation aims to cast a wide net so that it may supervise as many companies as possible, but also so that it may harvest as much information as possible from these same companies, so as to “monitor systemic risk and protect investors.” This will, of course, require that there are solutions on both the private and public sides of the information exchange to gather, review and process all of the financial data.

While, rightfully so, the reforms of the legislation have garnered the most attention, there is a common theme of consumer protection woven throughout. The cornerstone of this theme is the creation of the Consumer Financial Protection Bureau, which will be led by an independent director and have the power to write rules for all consumer financial products. Yet within the Bureau will be the Office of Financial Literacy, expanding the current Financial Literacy and Education Commission. This Office will provide the public with online content to better fiscal management and planning, mainly through its website. E-Learning tools will thus be needed to educate the public which may translate into more attractive M&A targets emerging within the E-Learning, Learning Management Systems and Learning Content Provider sectors.

Law firms appear split between excitement and apprehension. On one hand they will experience a large influx of business as their corporate clients seek to sift through the 2,300 page bill eager to undertake whatever steps necessary for compliance (whenever such action may become necessary), but the firms themselves are weary of the new rules themselves, perhaps fearing too many attorneys consumed in one-off work, as well as a consolidating client base. Yet whatever the ultimate impact upon law, the reforms, at least in the short term, will place large amounts of work upon firms that had previously been downsizing, necessitating efficient document management and communication tools. This need for optimized business solutions, combined with law firms perhaps eager to conduct either live or online seminars to both educate their clients and, ostensibly, advertise their own proficiencies, may translate into greater activity within the respective M&A markets. This trend may already have taken hold with Unify Corp. purchasing DAEGIS and AccessData Corporation’s announced acquisition of CT Summation, Inc.

The Financial Stability Oversight Council has also been approved with the bill’s passage, primarily to recommendations to the Federal Reserve for stricter rules regarding bottom line numbers such as capital, leverage, and liquidity on companies whose failure may adversely affect the financial system. This provision has allowed policy makers to address one particular buzz word from the past several years, “systemic risk.” The Financial Stability Oversight Council may also approve a decision by the Federal Reserve to demand divestiture on a particularly distressed or illiquid company, which, should such a measure become necessary, may present bargain opportunities for financial and strategic acquirers alike.

The Volcker rule (named for former Federal Reserve Chairman and current economic adviser to the President, Paul Volcker) has created something of a concern for banks since the President announced it in late January. Its intent was to curb banks proprietary trading and hedge or equity fund investment activity, essentially restoring some portions of the Glass-Stegall act repealed in 1999, namely the division between commercial and investment bank institutions. The legislative process considerably softened the provision limiting proprietary trading, and investment in and sponsorship of hedge funds and relationships with private equity. What had once read as three percent of tangible common equity allowed to be committed to the aforementioned activities had changed to three percent of Tier 1 capital, resulting in much greater headroom for the investments.

The bill has charged the Financial Stability Oversight Council with studying the specific definitions and restrictions imposed by the Volcker rule within six months, recommending revisions as they see fit, with the bill to be enacted within two years of the signing. There is a grace period installed, as well, so any possible divestiture required by such restrictions will not be seen till 3Q 2014.

The new legislation, while presenting challenges, presents an equal amount of opportunity for those poised to take advantage of a changing financial marketplace. Tempered and well vetted investments will, as always, find success, but the returns will be most handsome for those that can adapt both in practice and thought to a realigned economic environment.