While most of the country was riveted to the testimony of former FBI Director James Comey’s testimony before the Senate Intelligence Committee last week, members of the House of Representatives were buckled in for several hours of similarly divisive deliberations.
When it was all over, in the early evening of June 8, the Financial CHOICE Act earned a majority vote in the House of Representatives. The nearly 600-page bill passed with a party-line vote of 233 to 186. It now moves into the far greater challenge of passage in the Senate.
The House vote comes before a Treasury Department report due in the coming days that will detail the Trump administration’s plans for easing financial regulations. A lighter regulatory touch is already expected as a result of the administration’s appointments of banking industry veterans to serve as financial regulators.
Two big questions now emerge: (1) can the bill get past the Senate, even in a revised form; and (2) what are the likely effects for corporate America?
The legislation is a comprehensive package of rules and regulations intended to overhaul and replace what its architect, Rep. Jeb Hensarling (R-Texas), refers to as “the failed Dodd-Frank Act that has contributed to the worst economic recovery of the last 70 years.”
“Every promise of Dodd-Frank has been broken,” Hensarling said in a statement. “The Financial CHOICE Act … stands for economic growth for all, but bank bailouts for none,” he said. “We will end bank bailouts once and for all. We will replace bailouts with bankruptcy. We will replace economic stagnation with a growing, healthy economy.”
Among the many matters addressed in the sprawling bill:
Abolishing the Federal Reserve’s authority to supervise and set regulations for non-bank financial institutions;
directing the SEC to publish a manual establishing its enforcement policies and procedures;
eliminating the Volcker rule’s prohibition on proprietary trading;
exempting some financial institutions that meet capital and liquidity requirements from many of Dodd-Frank’s restrictions that limit risk taking; and
replacing Dodd-Frank’s method of dealing with large and failing financial institutions, known as the orderly liquidation authority, with a new bankruptcy code provision.
The legislation, if passed, would weaken the powers of the Consumer Financial Protection Bureau. Under the proposed law, the president could fire the agency’s director at will and its oversight powers would be curbed.
There were plenty of attacks on the bill before, during, and after the vote.
“The House Republicans are ramming through a bill … to roll back Wall Street reform and gut the CFPB. And despite all his tough talk on Wall Street, President Trump is proudly supporting this bill to ‘undo’ Dodd-Frank,” Sen. Elizabeth Warren (D-Mass.) said in a statement. “Consumer groups, civil rights groups, veterans’ groups—everyone who’s not a big bank—opposes this ‘wrong choice act.’ ”
Lisa Donner, executive director of Americans for Financial Reform, had a similar take on H.R. 10: “Lawmakers who voted for this bill are granting Wall Street megabanks and predatory lenders a license to defraud ordinary Americans and to put our economic security at risk for the narrow, short-term gains of a tiny elite.”
“Consumer groups, civil rights groups, veterans’ groups—everyone who’s not a big bank—opposes this ‘wrong choice act.’ ”
Sen. Elizabeth Warren, (D-Mass.)
A more hopeful thumbs-up for the bill comes from the National Association of Federally Insured Credit Unions. President and CEO Dan Berger praised passage of the legislation for efforts to ease some mortgage rules, require a review of appropriate risk capital levels, and rein in the CFPB’s authorities.
“NAFCU praises the passage of this important bill that, if enacted, would help provide the credit union industry with much-needed regulatory relief,” he said.
With similar praise, the Financial Services Roundtable called the House vote “an important step to advancing needed reforms to modernize the financial regulatory system in ways that promote greater economic growth while better protecting consumers.”
Setting aside the current rhetoric, and what the legislation’s fate may be in the Senate, companies and their counsel are intently analyzing the vote.
“The Financial CHOICE Act will have significant repercussions across the financial services community from commercial banking to private capital investors to small local lending institutions,” says Jeremy Swan, a principal with CohnReznick and national director for the firm’s private equity and venture capital practice.
In particular, he says, sections 858 and 859 of the CHOICE Act broaden Investment Company Act and Advisers Act exemptions to include private equity funds and fund managers would reduce the regulatory burden and exposure to SEC examinations for private equity funds.
“While, for many funds, this is seen as a positive, other limited partners have the opposite view, as the regulatory hurdles and SEC examination process has promoted transparency among their investments in private funds,” he says.
Less onerous restrictions on commercial banks with the repeal of many Dodd-Frank regulations “could hypothetically increase leveraged lending into private equity deals if the banks agree to hold larger reserves,” Swan says. “However, most large commercial banks have already invested heavily in Dodd-Frank compliance and are less than likely to forego the investment that has been made, in addition to raising the significant amount of capital to meet the increased reserve requirements.”
THE CHOICE ACT AND SEC ENFORCEMENT
The following are selections from a summary of the Financial CHOICE Act drafted by the House Financial Services Committee. It looks at proposed changes to the Securities and Exchange Commission’s enforcement authority.
All individuals who are either under investigation by the SEC or appear before the SEC in administrative proceedings must have a full and complete opportunity to defend themselves. The Financial CHOICE Act’s provisions affording defendants in SEC administrative proceedings a right of removal to federal court will help ensure that those defendants receive due process, and eliminate the unfair “home court advantage” that the SEC has sought to gain by steering cases to its in-house administrative law judges.
Over the past seven years, the SEC has increasingly turned to its own ALJs—rather than the federal courts—to adjudicate enforcement actions... SEC administrative proceedings are quasi-judicial proceedings in which ALJs appointed by the SEC adjudicate enforcement actions under SEC rules. While the SEC has publicly supported administrative proceedings as a more efficient way to resolve enforcement matters, critics have noted that administrative proceedings confer several advantages on the SEC and may deprive defendants of their due process rights.
The SEC’s recent penchant for imposing civil penalties on corporations that violate the federal securities laws instead of bringing enforcement actions against individual offenders also has raised concerns among SEC commissioners and other commentators that innocent shareholders are being penalized while the culpable corporate officers escape liability.
As a result of this policy, even though the SEC is collecting larger penalties from public companies, those penalties may not be having the intended effect. Corporate employees tempted to cut legal corners or engage in malfeasance will think twice if they know they are likely to pay a price for their wrongdoing. If it is far more likely that the costs will instead be imposed on the company or its shareholders, that deterrent effect is undermined.
Another concern is the SEC’s system for automatic disqualifications, in which individuals and other entities found to have committed certain bad acts, or deemed to have done so through the operation of a legal settlement with the federal government, are barred from engaging in certain activities or from relying on exemptions that otherwise would be available to them.
There has been increasing concern with the SEC’s growing practice of “rulemaking by enforcement.” In settlements, the Enforcement Division has mandated that settling defendants agree to “undertakings,” or remedial measures. These “undertakings” effectively have the force of new regulations because they put other market participants on notice that similar activities, even if not inconsistent with current regulations, could result in SEC enforcement actions.
These undertakings essentially amount to new compliance obligations imposed on corporations and individuals outside of the predictable regulatory process and the mandates of the Administrative Procedure Act, including the right of public notice and comment. As a result, rulemaking by enforcement has the potential to create greater uncertainty for market participants and deprive companies and individuals of essential due process protections.
It is time for the Commission to convene a new advisory committee, in a spirit similar to that of the Wells Committee, to conduct an independent review of the SEC's enforcement program and to recommend any needed changes to modernize enforcement practices.
The Financial CHOICE Act will require that the SEC Chairman convene a new Committee, with the same mission as the original Wells Committee, to holistically review the Enforcement program to ensure it comports with both with the SEC’s mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation and our constitutional due process rights.
The Financial CHOICE Act requires the SEC to implement policies consistent with the principles of predictability, fairness, and transparency. For example, to better protect innocent shareholders from further monetary harm, the legislation requires the SEC, when issuing a civil penalty against an issuer, to include findings, supported by the SEC Chief Economist, whether the alleged violations resulted in direct economic benefit to the issuer and the penalties do not harm the issuer’s shareholders.
The Financial CHOICE Act addresses constitutional concerns with the SEC’s enforcement program by giving respondents in SEC administrative proceedings the right to remove their enforcement action to federal court to ensure that the respondents’ due process rights are protected. It also requires the SEC to allow respondents to appear before the Commission prior to the initiation of a formal enforcement action, and establishes an Enforcement Ombudsman to review complaints about the Enforcement program.
Further, the SEC will be required to approve and publish an Enforcement Manual to ensure transparency and uniform application of its procedures.
Finally, the Financial CHOICE Act eliminates the system of automatic disqualifications and makes such disqualifications subject to the Commission’s discretion, thereby ensuring that the worst offenders can be barred from certain business activities and, if necessary, the industry.
Source: House Financial Services Committee
The assessment by Cliff Stanford, partner and chair of Alston & Bird’s bank regulatory group, previously assistant general counsel advising on banking regulation during his 15-year tenure at the Federal Reserve Bank of Atlanta: “Large financial institutions have already invested huge sums to comply with Dodd-Frank, so it may be challenging to roll back all its components.”
A centerpiece of the Dodd-Frank Act was also a bull’s-eye for Republicans.
“I don’t think we will see wholesale repeal,” says Doug Landy, a partner at the Milbank law firm. “It is always safe to bet against statutory change in financial services.”
He points to the Glass-Steagall Act as evidence of how slowly bank regulations evolve. It took more than 70 years for that rule to come off the books.
Even though both Democrats and Republicans have pledged a return to Glass-Steagall, Landy doesn’t see it happening. “It was the separation of securities and banking activities as people understood those words in 1932. Those words mean different things in 2017 than they did 85 tears ago.”
When Glass-Steagall was enacted, he says, there really was a difference between saving money in the capital markets through a bond versus making a loan to a commercial enterprise, Landy says. Today, there is little difference between a high-yield bond and a commercial loan. “In fact, many companies do the same product at the same time, in the same transaction with the same bank. The product is papered in almost identical ways.”
“There is very little practical reason why you would separate those activities going forward if the risks are not at all different any more,” he adds.
Landy’s suggestion for reforming the Volcker rule isn’t to replace it with some form or another of the Glass-Steagall Act. Instead, “look at the data and what is working and not working, adjusting accordingly,” he suggests. “The rule is broad in coverage and vague in definition. It requires you to look into the mind of a trader. Is that person intending to proprietary trade versus on behalf of a customer or something else that is allowed under Volcker? That is a very difficult test for a supervisor or examiner to satisfy.”
As economists have pointed out, there is a current lack of liquidity in many markets. “There are many factors, but Volcker is one of them and it is fair to study it,” he says. There is nothing saying that you can’t adjust some of the goalposts and try to stay within the confines of the rule, but also solving some of the issues banks have raised using the data that people have submitted.”
While much of the talk about last week’s vote has focused on “headline issues,” such as the regulatory burden for community banks, ending “too big too fail,” and the dismantling of the CFPB in its current form, other aspects of the legislation may be overlooked, says Rosemary Fanelli, a managing director and chief regulatory affairs strategist for Duff & Phelps.
“What we’ve been a little surprised about is that there has been very little talk at all about provisions that would be very significant for the investment fund industry, she explains, noting a provision that would remove the registration requirement for private equity firms.
SEC enforcement reforms are another matter slipping under the general public’s radar, Fanelli says. While the thresholds for SEC fines increase, the Commission also faces business-friendly reforms to the Wells notice process, limitations to the time frame of subpoenas issued by the agency, the creation of an ombudsman for companies under investigations, and procedural changes to in-house administrative judges.
Even if some rules eventually change, not all firms may take advantage of reprieves. The proposed registration rollback for private equity firms is among them.
“It will be hard for them to change what has become a market expectation by institutional investors,” Fanelli says. “Given the way industry has changed since Dodd-Frank, firms may not want to tell customers that they are not going to make certain public disclosures, or no longer going to maintain internal controls and a compliance program even though they might have good controls outside of a registration process. The perception from large institutional investors would not be a positive one.”
“I think everybody agrees at some level that there are parts of the Dodd-Frank Act, which was hastily passed and has thousands of pages, that could be refined, repealed, or structured in such a way that it is less onerous, less confusing, and less likely to lead to litigation,” says Jeffrey Taft, a financial services regulatory attorney with Mayer Brown.
Taft’s focus, in large part is on Title II resolution authority for large banks and the Volcker rule. “People have spent years gearing up for the rule, gearing up to deal with proprietary trading, and putting all these policies and procedures in place,” he says. “Banks have spent all this time spinning off a number of funds that are non-compliant with the Volcker rule, and now we are hearing that they are going to repeal it all.”
“I don’t think the banks would be upset about it being repealed,” he adds. “I do, however, think there is a lot of money that has gone into compliance. If it is repealed, all that work is going to have gone for naught.”
Among the overlooked aspects of the Financial Choice Act, in Taft’s opinion, is a Supreme Court decision in the case of Madden v. Midland Funding. The case called into question the ability of secondary market purchasers of loans to collect those loans at the interest rate charged by the bank that originated it.
“It has created uncertainty in the secondary market, especially around marketplace loans and the peer-to-peer lenders like Lending Club, Avant, and Prosper who are using bank partners to originate those loans and then selling them, effectively, into the secondary market to hedge funds and other investors,” Taft said.”
The legislation would do away with the Supreme Court decision by establishing that interest rates may remain in place even if an initial debt is sold or repackaged.
Many of the current Financial Choice Act debates may ultimately prove to be merely academic.
It is an enormous and very complex piece of legislation that has extremely little bipartisan support, says David Tittsworth, investment management counsel with law firm Ropes & Gray. The divisive debate in the House underscores the fact “that there is no appetite among Democrats to pass such a bill.”
“Accordingly, the CHOICE Act is likely to hit a brick wall in the Senate,” he says, adding that all 52 Republicans plus eight Democrats would have to vote in favor of the bill in order to invoke closure in the Senate. “Few predict that the bill will receive any meaningful consideration by the Senate.”
There is certainly the possibility, however, that pieces of the Financial CHOICE Act could garner bipartisan support at some point, “though it is difficult to predict now what those pieces may be,” Tittsworth says. Other factors, such as reports that the Treasury Department will issue in the coming weeks, “could also play a role in determining whether smaller bills may be possible serious legislative candidates down the line.”
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