Dodd-Frank Section 342: An Analysis of an Emerging Regulation Impacting the Financial Services Industry

About the Authors:

Anthony M. Sharett is a partner at Baker & Hostetler LLP in Columbus, Ohio.

The 2008 financial crisis caused widespread hardship to consumers and the financial services industry. Statistics demonstrate that communities of color, some of which were targeted by predatory practices, were disproportionally impacted both as consumers and employees of financial services companies. Likewise, large institutions’ efforts to utilize women-owned and minority-owned businesses decreased significantly during the economic downturn. The impact from the financial crisis has been long-lasting for diverse populations and many believe that concerted efforts to promote diversity ideals have been severely undermined.

In 2010, to address these issues, members of the Congressional Black Caucus, led by Congresswoman Maxine Waters, began to propose legislation that had two goals: (1) prevent downturns from disproportionally impacting minority communities, employees, and businesses; and (2) ensure that financial services companies are held accountable through data collection and self-analysis. As a result, Congress passed Section 342 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 342 created Offices of Minority and Women Inclusion (OMWI) in federal agencies that regulate the financial services industry.

The goal of these standards is to provide a framework for regulated entities to promote transparency and awareness of diversity policies and practices within the entities regulated by the agencies. Specifically, OMWIs are charged with creating standards to diversify the financial sector's hiring and contracting opportunities. Of course, this represents a historic pivot to improve connections between financial institutions and our nation's fastest-growing communities, potentially generating trillions of dollars in investment.

Notably, the standards provide that entities voluntarily perform self-assessments and voluntarily report the results of these assessments to the agencies and to the public. This article provides an overview of Section 342.

Background

As a result of the efforts of the Congressional Black Caucus and others, on June 10, 2015, the Office of Comptroller of the Currency (OCC), Governors of the Federal Reserve System (Board), Federal Deposit Insurance Corporation (FDIC), National Credit Union Administration (NCUA), Consumer Financial Protection Bureau (CFPB), and Security Exchange Commission (SEC) (each an “Agency” and collectively, the “Agencies”) issued a Final Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of the entities they regulate (Joint Standards) as required by Section 342 of the Dodd-Frank Act. See 80 Fed. Reg. 33016 (June 10, 2015).

The Agencies’ respective OMWI offices created the Joint Standards. Section 342 directs each Agency to establish an OMWI office. See 12 U.S.C. § 5452. Each OMWI office is headed by a director who is responsible for all Agency matters relating to diversity, including without limitation, management, employment, and business activities. Critically, Section 342(b)(2)(C) directs each Agency’s OMWI director to develop standards for assessing the diversity policies and practices of entities regulated by that Agency.

The Joint Standards provide five areas that a regulated entity may consult to develop its diversity policies and practices:

  • Organizational Commitment to Diversity and Inclusion;
  • Workplace Profile and Employment Practices;
  • Procurement and Business Practices;
  • Practices to Promote Transparency and Organizational Diversity and Inclusion; and
  • Self-Assessment. See 80 Fed. Reg. 33016, 33023.

On October 25, 2013, the Proposed Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agencies (Proposal) identified proposed standards for a regulated entity’s diversity and inclusion policies and practices. As a result of the Proposal, the Agencies received comments from the industry, consumers, trade associations, academic scholars, and others, and finalized the rule in June, 2015. Smaller institutions such as community banks, credit unions, and small dollar lenders provided several comments to the Proposal. Many of these institutions were concerned that they do not have the financial resources or personnel to comply with the Joint Standards related to self-assessment, implementation, and reporting. To address these concerns, the Joint Standards provide that these standards may be met based upon an institution’s size and other factors such as geographic location, community characteristics, number of employees, corporate structure, and customer base.

One criticism about the Joint Standards is that they do not require regulated entities to disclose specific information about their diversity policies and practices. Instead, information that is disclosed will be used by the Agencies to identify industry best practices regarding the Joint Standards. Despite several negative comments from agencies, affinity groups, academic scholars, and consumer groups, and unlike other Dodd-Frank provisions involving securities and lending, none of the Agencies have the authority to enforce the Joint Standards. Indeed, the Joint Standards rely on (1) a voluntary self-assessment by regulated entities, (2) a voluntary disclosure of the self-assessment to the Joint Agencies, and (3) a voluntary display of diversity information on the public websites. Critically, the Agencies may not utilize their examination and supervisory authority in connection with these standards.

Voluntary Participation and No Enforcement Mechanisms

Perhaps the most debated aspect of Section 342 is that it provides no authority to the Agencies to enforce the provisions. Rather, the Joint Standards outline a voluntary approach for regulated entities regarding self-assessment and reporting. Specifically, the final rule explains that the Agencies will use neither supervisory nor examination authority to enforce Section 342 rules.

Section 342 proponents filed several comments regarding the Agencies’ lack of enforcement authority. Simply put, many supporters believe that without Agencies’ enforcement authority, regulated entities will not commit programmatically, quantitatively, or financially to ensure that the Joint Standards are implemented. Indeed, as the saying goes, a nail is no good without a hammer.

The industry should be aware, however, that the OMWI directors will discuss diversity and inclusion practices and methods of assessment with regulated entities and other interested parties. Likewise, the Agencies will analyze disclosed information to determine industry best practices regarding diversity and inclusion. Hence, theoretically, if the Agencies determine that the industry is failing to adequately implement Section 342 programs, they could reevaluate the position regarding non-enforcement.

Navigating the Joint Standards

The Joint Standards focus primarily on institutions with more than 100 employees. “Minorities” are defined as Black Americans, Native Americans, Hispanic Americans, and Asian Americans which is the same definition as Section 342(g). Companies are permitted, however, to use a broader definition of “minorities” within their organizations.

The Joint Standards define “inclusion” as “a process to create and maintain a positive work environment that values individual similarities and differences, so that all can reach their potential and maximize their contributions to an organization.”

OMWIs must create standards for workforce and supplier diversity (procurement with diverse vendors) for their respective agencies and the over 70,000 companies they regulate. Each OMWI director shall develop standards for the following areas:

  • Equal employment opportunity and the racial, ethnic, and gender diversity of the workforce and senior management of the agency;
  • Increased participation of minority-owned and women-owned businesses in the programs and contracts of the agency, including standards for coordinating technical assistance to such businesses; and
  • Assessment of the diversity policies and practices of entities regulated by the agency.

Regulated entities are to consider these five factors to understand their pledge to diversity and inclusion:

  • Company commitment to diversity and inclusion;
  • Workforce profile and employment procedures;
  • Supplier diversity concepts;
  • Transparency of organizational diversity and inclusion (outward facing); and
  • Self-assessment.

These concepts are purposefully abstract. A robust diversity and inclusion program will vary from company to company for a host of reasons. Because these concepts do not go to the heart of traditional examination concepts such as safety and soundness and consumer protection, fluid concepts are more appropriate.

Further, these five concepts are intended to facilitate transparency and awareness of levels of commitment for the public. To be sure, academic scholars, various studies, and the Agencies all theorize that a thorough diversity and inclusion program promotes an increase in business productivity because companies can ultimately serve a wider customer base.

Company Commitment to Diversity and Inclusion

Unlike grassroots politics, companies should utilize a C-suite, board-level approach when considering the Joint Standards. Irrespective of corporate structure (board of directors, privately held, publicly traded, management directed) the Joint Standards emphasize that a leadership driven model is the expectation.

To this end, an entity can properly demonstrate organizational commitment by:

  • Integrating diversity and inclusion considerations into employment and contracting as part of short-term and long-term strategy planning.
  • Requiring that the board, C-suite executives, and other influential leadership receive regular reports regarding objectives.
  • Utilizing internal or external persons to prepare and implement robust diversity and inclusion policies and procedures.
  • Appointing a director level person to supervise the entity’s diversity efforts.
  • Hosting continuous diversity and inclusion education and training.
  • Ensuring that new position candidate pools are diverse and reflective of the communities served by the entity.

Workforce Profile and Employment Procedures

The Joint Standards suggest several ways that a regulated entity may promote diversity and inclusion concepts within the workplace. First, an entity should endeavor to foster relationships with affinity organizations both locally and broadly. Second, entities should incentivize with employee bonus compensation and create mechanisms to evaluate directors, managers, and officers regarding the success of these concepts.

Many of the Joint Agencies are data-driven agencies. Indeed, quantitative evaluations led to the creation of Section 342. Thus, the Joint Standards suggest that regulated entities create benchmarking mechanisms to objectively evaluate results.

Supplier Diversity Concepts

Supplier diversity programs have existed for decades. This is particularly true for companies that seek government contracts. Implementing a robust supplier diversity program can be a full-time job for one or several company employees.

While a supplier diversity program can be challenging to create and foster, successful implementation can increase a company’s profile and can build credibility in a way that leads to increased profitability. In a very basic way, entities are encouraged to contract with and hire minority-owned and women-owned businesses, and then increase these relationships.

The most obvious way to increase these figures is by working with minority-owned and women-owned vendors and sub-vendors. Further, outreach to certain trade and targeted affinity organizations and attendance at conferences which attract minority-owned and women-owned firms are best practices to meet this standard.

Ability to Promote Transparency of Organizational Diversity and Inclusion

Perhaps no concept of Section 342 causes more heartburn among regulated entities than this provision. The Joint Standards promote awareness and transparency leading to an expectation that entities provide the public with diversity and inclusion benchmarking information that allows individuals to assess a company’s commitment. Publishing diversity-related information on corporate websites, marketing materials, and reports is one way to meet this goal.

Transparency may also include publicizing the company’s diversity and inclusion plan, targeted job postings, supplier diversity information, testimonials, employment and business related success stories, and any local philanthropic efforts. Studies have shown that consumers, particularly millennials, want to understand a company’s commitment to community stewardship and to diversity and inclusion ideals before choosing with whom to do business. Consequently, while transparency may be difficult to achieve, it could be a business opportunity for regulated entities.

Self-Assessment

Self-assessment without regulatory analysis and/or examination could be a component that entities may find difficult to implement. But in reality, the companies themselves may be in the best position to understand performance with benchmarking. Accordingly, companies may embark in a modified SWOT analysis (strengths, weaknesses, opportunities, and threats) to ascertain areas of strength and weakness in their own policies and programs with either an internal or external approach. A regulated entity’s successful diversity program should include allocation of time and resources to monitor and evaluate progress of its diversity and inclusion and suppler diversity concepts.

Agencies encourage regulated entities to disclose diversity policies and practices as well as self-assessment information to the public and to the respective entities’ primary federal financial regulator. Companies may label information as “confidential commercial information” pursuant to the Freedom of Information Act.

Finally, entities should consider how they monitor and evaluate performance concerning diversity policies and practice and understand that using the Joint Standards as a baseline in the self-assessment stage will likely be proof of a sufficient self-assessment program.

Conclusion 

The disproportionate impact that the economic downturn had on diverse communities, diverse consumers, and minority and women-owned businesses led to legislators taking note and implementing corrective action through legislation. The Agencies that will review information provided by companies implementing these Joint Standards will be analyzing whether companies are uniformly adopting conforming policies and procedures regarding diversity and inclusion and then determining if the programs are actually meeting the goals of Section 342. Likewise, potential business advantages of applying the Joint Standards and the favorable reaction of their regulators to companies that incorporate these new programs into their compliance management systems should encourage companies to fully implement and embrace these voluntary standards.

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