Financial Reform and Small Business

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The massive 2,300-page Dodd-Frank Wall Street Reform and Consumer Protection Act, while having little direct impact on closely-held private businesses, will affect all businesses as they apply for loans, pay fees on credit card transactions, and interact with their banks and the financial markets.

Despite all of the hoopla accompanying the passage of the financial reform legislation, the full contours of the new Bureau of Consumer Financial Protection, the Financial Stability Oversight Council, the Office of Financial Research, and dozens of new rules and regulations from the SEC and other agencies will not be known for months or even years.

More than 500 regulatory rule-making efforts, 60 studies, and 93 reports are underway.

Once these are completed, the banks and financial institutions to which businesses look for loans and capital will be governed by new rules and will have to bear additional operating costs. In the meantime, there may be hesitation in providing loans and funds as financial institutions try to understand the new lay of the land.

Some business groups fear that the new act and the ensuing regulations will restrict small business bank lending. Others observe that banks have already restricted their lending and express hope that the new rules will create a more stable system that will catalyze new lending. No matter how the rules play out, however, there will be additional costs imposed upon banks and other lenders, leading to increased costs to borrowers.

Small businesses attempting to raise capital under Reg D “accredited investor” offerings will be adversely impacted by the exclusion of a prospective investor’s primary residence from the “net worth” test for determining “accredited investor” status. Prior to the Act, a person could pass muster if she or he either had a net worth exceeding $1 million (individually or with a spouse) or had income exceeding $200,000 in the two most recent years (or $300,000 with one’s spouse) and a reasonable expectation of that level of income in the present year.

The new rule excludes a prospective investor’s primary residence from the “net worth” test, thus reducing the pool of accredited investors. Now that semi-retired uncle living in a nice house or that up-and-coming young friend (who put her big bonus into a home, but does not yet have three years of $200,000 income) will not be able to participate in an accredited investor-only offering. Sales to non-accredited investors require substantially greater disclosure (and increased legal and accounting fees).

While many fund raising efforts may not be negatively impacted by the “primary residence” exclusion, most “friends and family”-focused offerings will face greater challenges in identifying accredited investors. One accommodation afforded by the SEC, however, is that mortgage debt (so long as it does not exceed the value of one’s home) may be disregarded in determining an investor’s net worth. Looking ahead, the SEC is charged with reviewing and adjusting the income and net worth thresholds every four years.

Retailers stand to gain by the mandate to the Federal Reserve that within nine months it establish rules on debit card transaction fees. The fee must be reasonable and proportional to the cost incurred by the card issuer; in the end, retailers will likely pay less with every debit card purchase.

In the same vein, the Act permits a retailer to set minimum transaction amounts on debit card transactions (not exceeding a $10 minimum) and to offer discounts to consumers who don’t use debit or credit cards. The Act also prohibits bank-imposed network rules restricting retailers in the number of debit card networks with which they are affiliated or requiring that transactions be routed over a particular network.

The Act will permits banks (in 2011) to pay interest on demand deposit accounts, but it is not required. The ability to pay interest on business checking accounts would benefit small businesses if the practice were widely adopted by banks as a means to attract deposits.

Yet to be known is the eventual reach of the Bureau of Consumer Financial Protection’s “consumer financial product or service” rules upon retailers offering long or short term payment or installment plans. While SEC-regulated companies, car dealers, real estate agents, 401(k) and IRA plans, and certain banks enjoy an exemption under the Act, the CFPB rules may affect sellers of furniture, jewelry or other retailers that sell by installment plans. The debate will be over whether such retailers are engaged “significantly” in offering or providing consumer financial products or services.

The systemic impact of the Dodd-Frank Act upon the economy, the financial system, and — in turn — private businesses will be more fully realized as the many studies are completed, new rules and regulations are promulgated, and the country’s financial institutions react and evolve.

About the author: William E. Carlson is a senior partner, firm president and the chair of the Business Department at Shapiro Sher Guinot & Sandler. He concentrates in corporate and securities law, in which he advises clients in mergers and acquisitions, equity and debt financings, joint ventures, technology transfer and licensing, employment and consulting arrangements, and general corporate planning.