On June 8, the House of Representatives passed a revised version of the Financial CHOICE Act (the “Act,” available here) in a 233-186 vote. The Act would repeal or modify significant portions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and addresses a wide range of other financial regulations. This bill is the second version of a reform bill that was introduced last year by committee Chairman Jeb Hensarling (R-Texas). In many respects, the Act echoes priorities raised in President Trump’s executive order signed on February 3 (see our client alert here) setting forth “Core Principles” intended to guide the regulation of the U.S. financial system and in his presidential memoranda calling for review of certain features of the Dodd-Frank Act (see our client alert here).
A variety of interest groups, including the Council of Institutional Investors, have expressed strong opposition to the bill, and the chances of the Senate passing the bill in its current form appear low. Nevertheless, the bill will serve as an important reference point in the negotiation of legislation able to attract both House and Senate support. Any final legislation would likely include provisions designed to encourage capital markets activities in the United States and could also address certain provisions of the Dodd-Frank Act, such as those relating to pay ratio and conflict mineral disclosure, that have been the subject of substantial controversy and litigation.
Key provisions of the Act are summarized below.
Reform of Financial Institution Regulation
Title I of the Act would alter substantially the framework of bank and nonbank financial institution regulation established by the Dodd-Frank Act, and would repeal many of the Dodd-Frank provisions designed to address systemic risk in the financial system.
- Repeal of Orderly Liquidation Authority. The Act would repeal Title II of the Dodd-Frank Act, which established an Orderly Liquidation Authority pursuant to which the Federal Deposit Insurance Corporation (“FDIC”) may seize, wind down and break up a failing financial company whose failure threatens financial stability in the United States. The Act would replace the Orderly Liquidation Authority with a new chapter of the Bankruptcy Code designed to accommodate the failure of large, complex financial institutions. Proponents argue that such a change would bring the benefit of the greater impartiality and certainty of the judicial system, together with the elimination of potential dependence on taxpayer-provided funds in connection with large financial institution failures (the so-called “too big to fail” problem).
- Repeal of Financial Stability Oversight Council (“FSOC”) Authority. The Act would:
- Repeal FSOC authority to designate certain nonbank financial institutions as systemically important and rescind previous FSOC designations of nonbank financial institutions as systemically important;
- Repeal FSOC authority to designate “financial market utilities” as systemically important; and
- Repeal FSOC authority to order a bank holding company or a nonbank financial institution to sell or transfer assets upon the recommendation of the Federal Reserve.
- Limitations on Use of Federal Funds. The Act would:
- Repeal the systemic risk exception to the FDIC’s obligation to use the deposit insurance fund to rescue failing banks using the least costly method;
- Prohibit the use of the Exchange Stabilization Fund to establish guaranty programs for financial institutions; and
- Repeal the authority of the Federal Reserve to provide financial support to designated “financial market utilities.”
- Limitations on Federal Reserve Authority. The Act would:
- Abolish the Federal Reserve’s authority to supervise and set regulations for nonbank financial institutions; and
- Exempt “qualifying banking organizations” from the Federal Reserve’s authority to set more stringent prudential standards for bank holding companies.
- Living Wills. The Act would remove the FDIC from the process of evaluating “living wills,” leaving exclusive authority with the Federal Reserve. This is linked to the proposed elimination of the Orderly Liquidation Authority. The requirement that large bank holding companies and certain nonbank financial companies maintain plans for their rapid and orderly shutdown in the event of material financial distress or failure (so-called “living wills”) was established under the Dodd-Frank Act.
- Stress Testing. The Act would streamline the stress testing process for bank holding companies by requiring that they be conducted once a year rather than semi-annually.
Increased Penalties under Federal Securities Laws
Title II of the Act would increase the civil money penalties that may be sought in administrative and civil actions brought under the federal securities laws. It also would add a new category of monetary penalties in administrative and civil actions brought under the federal securities laws for recidivists, would increase the civil monetary penalties that the Public Company Accounting Oversight Board may impose in actions brought under the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”), and would increase the civil monetary penalties that the SEC may seek against “controlling persons” in insider trading cases (increasing the limit from $1 million to $2.5 million in instances where that amount would not be greater than three times the amount of the profit gained or loss avoided). Title II also would increase the civil monetary penalties that the SEC may seek under the Securities Exchange Act of 1934 (the “Exchange Act”) and would increase the civil and criminal penalties originally established in the Financial Institutions Reform, Recovery and Enforcement Act of 1989.
Stricter Oversight of Financial Regulators
Title III of the Act would significantly change the financial rulemaking process. It would direct federal financial regulatory agencies to include in proposed rulemaking a more rigorous cost benefit analysis than currently required, including regulatory analyses that, among other things, identify the need for regulation and the regulatory objective (including identification of the market or regulatory failure that makes regulation necessary); identify alternatives to the proposed regulation and explain why private market or nonfederal authorities cannot address the problem; identify all available alternatives to the regulation; assess the costs, benefits and consequences of the proposed regulation; and describe the data relied upon in analyzing the proposed regulation. It also would grant individuals the right to bring actions in the D.C. Circuit Court seeking review of an agency’s compliance with these requirements. The effect of these requirements would likely be to slow the financial rulemaking process.
Title III would also prohibit federal financial regulatory agencies from issuing a notice of final rulemaking if costs are greater than benefits without a joint resolution from Congress directing the agency to proceed with the rulemaking and, importantly, would require that Congress approve by joint resolution any rules having an annual effect on the economy of $100 million or more. It also would direct federal financial regulatory agencies to implement policies that minimize duplication of enforcement actions and would prohibit them from using settlement proceeds to make payments to persons who were not directly harmed by the wrongdoing that led to the settlement.
In addition, Title III would direct courts reviewing the actions of federal financial agencies to use a de novo standard of review when deciding all questions of law relating to an agency action, including the interpretation of constitutional and statutory provisions and the rules promulgated by an agency. This runs contrary to the currently prevailing doctrine of judicial deference to agency interpretation of statutes, commonly referred to as the “Chevron Doctrine.” By limiting the power of financial agencies to interpret their own rules, this measure would substantially alter the long-standing framework of administrative law that has applied to U.S. financial regulation.
Significantly, Title III would eliminate the self-funding of numerous financial agencies, including the Office of the Comptroller of the Currency (“OCC”) and the FDIC and subject them to the annual appropriations process. Assessments and fees collected by the agencies would be then used to reimburse the federal government.
Provisions Facilitating Capital Formation
Title IV of the Act includes a number of provisions directed at facilitating capital formation. Among other things, it would:
- Exempt firms engaged in intermediating mergers and acquisitions from the broker-dealer registration requirements of the Exchange Act;
- Direct the SEC to increase from $5 million to $20 million the threshold set forth in Rule 701(e) of the Securities Act of 1933 (the “Securities Act”) above which issuers must provide financial statements and other information for securities offered as part of compensatory benefit plans;
- Exempt Emerging Growth Companies (“EGCs”) and other smaller companies from the SEC’s eXtensible Business Reporting Language (“XBRL”) requirements for financial statements;
- Direct the SEC to revise Form S-3 to expand the eligibility of smaller companies that may use the short-form registration statement for offerings, permitting its use where the aggregate market value of the voting and nonvoting common equity held by nonaffiliates of the registrant is $75 million or more or the issuer has at least one class of listed equity securities;
- Amend the Securities Act to liberalize the private resale exemption contained in Section 4(a)(7) (the codification of the so-called “Section 4(a)(1½)” legal framework for resales of restricted securities by persons other than the issuer) to eliminate information requirements and permit general solicitation, so long as sales are made through a platform available only to accredited investors;
- Grant certain low-revenue issuers (with average annual gross revenues of less than $50 million as of its most recently completed fiscal year) a temporary exemption from Section 404(b) of the Sarbanes-Oxley Act, which requires auditors of public companies to attest to, and report on, management’s assessment of internal control over financial reporting;
- Direct the SEC to revise its rules to clarify that the prohibition in Regulation D against general solicitation and general advertising does not apply to certain presentations or communications made at events sponsored by institutions of higher education, nonprofit organizations, angel investor groups, venture forums, venture capital associations and trade associations;
- Direct the SEC to revise Regulation D to streamline the filing requirements and procedures for issuers offering securities under Regulation D, requiring the filing of a single notice of sales and prohibiting the SEC from requiring any additional materials;
- Require proxy advisory firms to register with the SEC and set forth the procedure for registration;
- Amend Section 3(b)(2) of the Securities Act to raise the amount of securities that may be offered and sold within a 12-month period under the exemption for additional issues authorized by the JOBS Act from $50 million to $75 million; and
- Amend the Securities Act to allow all issuers, not just EGCs and certain foreign private issuers, to submit draft registration statements to the SEC for confidential, nonpublic review before an initial public offering, provided that the registration statement and all amendments are publicly filed not later than 15 days before the first road show.
Regulatory Relief for Smaller Financial Institutions
Title V of the Act addresses a wide variety of regulations applicable to consumers of financial products and community financial institutions. It would relax certain regulatory regimes relevant to financial institutions, including those established by the Federal Financial Institutions Examination Council Act, the Federal Credit Union Act, the Home Owners’ Loan Act, the Equal Credit Opportunity Act, the Federal Deposit Insurance Act and the Home Mortgage Disclosure Act. It would also amend the Truth in Lending Act to provide a safe harbor against litigation for mortgage originators in respect of residential mortgage loans that fail to comply with that Act’s ability to repay requirements.
Regulatory Relief for Banking Organizations Maintaining Prescribed Leverage Ratios
Title VI of the Act would provide an “off-ramp” from the post-Dodd-Frank supervisory regime and Basel III capital and liquidity standards for a banking organization that elects to be treated as a “qualifying banking organization” and maintains a nonrisk weighted average leverage ratio of at least 10% (e., the average of its leverage ratios for the four most recently completed calendar quarters). Among other things, these entities would be exempt from federal laws and regulations that set capital and liquidity requirements, federal laws and regulations that permit federal banking agencies to object to capital distributions, and laws placing limitations on mergers and acquisitions relating to capital and liquidity standards. Federal banking agencies would be prohibited from considering a qualifying banking organization’s effect on systemic risk or financial stability.
The off-ramp could provide financial institutions able to meet the average lending ratio—including small and medium-sized institutions and community banks, which are more likely to able to do so—with a mechanism for avoiding a significant portion of the bank regulatory structure established by the Dodd-Frank Act.
Restructuring of the Consumer Financial Protection Bureau
Title VII of the Act would significantly restructure the Consumer Financial Protection Bureau (“CFPB”) and reduce its authority and independence. In addition to renaming the CFPB as the “Consumer Law Enforcement Agency” (the “Agency”) and removing the provision that states that the Director of the agency can only be removed by the President for cause, thus rendering it no longer an independent agency, the Act would:
- Make the Agency subject to Congressional appropriations;
- Authorize the recipients of a civil investigative demand issued by the Agency to seek an order from a federal district court modifying or setting aside the demand;
- Repeal the provision in the Consumer Financial Protection Act requiring courts to defer to the determinations of the Agency regarding the meaning of federal consumer financial law;
- Abolish the Agency’s authority to supervise and examine financial institutions;
- Provide that the Agency may not exercise any rulemaking, enforcement, or other authority relating to employee benefit compensation plans or persons regulated by the SEC or the CFTC;
- Prohibit the Agency from exercising rulemaking or enforcement authority over small dollar loans (“payday loans”);
- Notably, not repeal the Federal Reserve’s authority to issue regulations setting interchange transaction fees and network fees (as established by the “Durbin Amendment”), a provision that had been included in the version of the bill passed by the House Financial Services Committee but that had been strongly resisted by the retail industry; and
- Repeal the Agency’s authority to restrict agreements requiring pre-dispute arbitration in connection with the offering or providing of consumer financial products or services.
Capital Markets Reforms
Title VIII of the Act would make numerous changes to the structure and policies of the SEC and would mandate changes to the regulation of the capital markets. Among other things, the Act would:
- Direct the SEC and registered national security associations, in consultation with the SEC’s chief economist, to develop internal risk controls to safeguard market data;
- Subject SEC statements and guidance that implement, interpret, or prescribe law or policy, including interpretive rules, general statements of policy, and rules of SEC organization, procedure or practice, to the notice-and-comment requirements of the Administrative Procedure Act;
- Direct the SEC to establish a process in which the recipient of a Wells notice can make a presentation to SEC staff regarding the staff’s preliminary recommendation that the SEC bring an enforcement action against the recipient of the notice;
- Direct the SEC to publish a manual setting forth the policies and procedures the SEC follows in enforcing the securities laws; and
- Provide that entities and individuals may not be automatically disqualified under so-called “bad actor” provisions from using exemptions or registration provisions as a result of having been the subject of an order, judgment, or decree arising from a governmental action.
Title VIII would also scale back a number of regulations applicable to the capital markets, many of which were mandated by the Dodd-Frank Act. Among other things, it would:
- Require that shareholders be given the opportunity to approve executive compensation only in those years in which the executive compensation of an issuer has materially changed from the previous year (rather than the existing standard, which is not less frequently than once every three years);
- Direct the SEC to revise the holding requirements for a shareholder to submit a proposal by eliminating the option to satisfy the requirement by holding a certain dollar amount (currently $2,000 in market value) and by requiring a shareholder to hold 1% of the issuer’s voting securities, and also adjusting the holding period to three years;
- Prohibit an issuer from including in the issuer’s proxy materials shareholder proposals made by persons in their capacities as proxies, representatives, agents or other persons acting on behalf of a shareholder;
- Prohibit the SEC from requiring proxy solicitations to use a universal ballot for director elections (a mechanism proposed by the SEC in October 2016, as described in our client alert);
- Exempt issuers with market capitalizations of less than $500 million and depository institutions with assets of less than $1 billion from having to comply with the internal control evaluation requirement under Section 404(b) of the Sarbanes-Oxley Act;
- Provide that any SEC rule adopted under Section 10D of the Exchange Act requiring issuers to develop policies providing for the recovery of compensation awarded to an executive officer during the three years preceding an accounting restatement due to material noncompliance with financial reporting requirements (“clawbacks”) would apply only when the officer had control or authority over the financial reporting that resulted in the accounting restatement. This would be a significant curtailment of the existing Dodd-Frank Act requirement, which does not include a control or authority requirement;
- Exempt asset-backed securities made up of nonresidential mortgages from the Dodd-Frank Act’s risk-retention requirements;
- Amend various provisions regarding the oversight of Nationally Recognized Statistical Rating Organizations, which issue SEC-permitted credit ratings for use by financial firms for regulatory purposes; and
- Repeal certain provisions of the Dodd-Frank Act, including those:
- Requiring issuers to disclose the ratio of the median annual compensation of all employees and the compensation of the chief executive officer (Section 953(b));
- Mandating disclosure by issuers regarding employee and director hedging (Section 955); and
- Directing the SEC to promulgate regulations regarding disclosures relating to conflict minerals originating in the Democratic Republic of the Congo (Section 1502), disclosures regarding coal or other mine safety (Section 1503), and disclosures of payments to foreign governments by resource extraction issuers (Section 1504) (we have addressed the latter issue in more detail in a recent client alert).
Repeal of the Volcker Rule
Title IX of the Act would repeal the so-called “Volcker Rule” provisions of the Dodd-Frank Act, which prohibit banking entities from engaging in proprietary trading or maintaining certain relationships with hedge funds and private equity funds. In addition, Title IX would repeal sections of the Dodd-Frank Act imposing a moratorium on the provision of deposit insurance by the FDIC to industrial banks, credit card banks, and trust banks owned or controlled by a commercial firm; granting the Federal Reserve supervisory authority over securities holding companies; and prohibiting underwriters, placement agents, initial purchasers and sponsors of an asset-backed security from engaging in transactions that give rise to a conflict of interest with an investor in the security for a one-year period.
Reform of the Federal Reserve
Title X of the Act would address the functioning of the Federal Reserve, including a requirement that it adopt a “directive policy rule” subject to monitoring by the Government Accountability Office (the “GAO”). In addition, Section 13(3) of the Federal Reserve Act would be amended to provide that the Federal Reserve may exercise its emergency lending authority only if the “unusual and exigent circumstances” identified as the basis for the exercise of such authority also “pose a threat to the financial stability of the United States.” Title X also would provide that federal banking regulators must certify that an institution is solvent before it is eligible to borrow under the Federal Reserve’s emergency lending authority and would direct the GAO to annually audit the Federal Reserve and Federal Reserve Banks and report to Congress the results of its audit.