United States: Why The Future Of Dodd-Frank May Depend On CHOICE Act 2.0

Repealing or substantially modifying the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) remains a top priority of Republican lawmakers. The latest attempt to do so is in the form of a comprehensive regulatory reform bill labeled the Financial CHOICE Act of 2017 (CHOICE Act 2.0), which was introduced by the bill's sponsor, Jeb Hensarling, R-Texas, chairman of the House Financial Services Committee, in April 2017. CHOICE Act 2.0 is a modified version of the original bill, the Financial CHOICE Act of 2016, which was introduced by Chairman Hensarling in June 2016 to the House Financial Services Committee but failed to advance to the U.S. House of Representatives. CHOICE Act 2.0 passed the House Financial Services Committee on May 4, 2017, and passed the U.S. House of Representatives on June 7, 2017, in a party-line vote (233 to 186). All but one Republican voted for CHOICE Act 2.0, and all Democrats opposed it. Although the bill now must be approved by the U.S. Senate, it is not expected to receive the required 60 votes to pass, unless it undergoes substantial revisions to garner Democratic support. However, it is possible that portions of the proposed legislation may be passed by the Senate.

Despite the uncertainty, it is clear that Republican lawmakers will continue to seek regulatory reforms, whether through CHOICE Act 2.0 or some other legislation. It seems equally clear that any proposed reform passed by the House of Representatives will likely be subject to significant negotiations and extensive modification during the legislative process, at least in the Senate. Regardless, CHOICE Act 2.0 provides valuable insight as to the areas on which Republican lawmakers are focused and the provisions that may be targeted for repeal or modification. We urge companies to continue to monitor the status of these proposals and, in cases where rules promulgated as a result of Dodd-Frank are set to take effect, to continue to prepare for implementation.

Below is a summary of the key provisions of Dodd-Frank that may be affected by CHOICE Act 2.0. We have also included other notable provisions of CHOICE Act 2.0 that, if approved, would impact capital formation.

Pay ratio ‒ Item 402(u) of Regulation S-K, which was promulgated as a result of the requirements of Dodd-Frank, requires public reporting companies to disclose their median employee's total annual compensation as a ratio to the total annual compensation of their chief executive officer (Pay Ratio Rule). The Pay Ratio Rule is effective beginning on a company's first fiscal year beginning on or after January 1, 2017. Thus, most reporting companies will be required to include pay ratio disclosure in their proxies during the 2018 proxy season. If passed, CHOICE Act 2.0 would repeal the Dodd-Frank requirement for adoption of the Pay Ratio Rule.

In February 2017, then-acting chairman of the Securities and Exchange Commission (SEC), Michael S. Piwowar, issued a public statement questioning the Pay Ratio Rule, directed the SEC to reexamine the rule, and asked the public to submit comments on any unexpected challenges experienced and whether relief is needed. During the 45-day comment period, the SEC received approximately 180 comment letters, of which approximately 85 percent were in favor of the Pay Ratio Rule, as well as approximately 14,000 form letters in favor of pay ratio disclosures.

We recommend that public reporting companies continue to prepare for implementation of the Pay Ratio Rule, as any relief or delay in the implementation is uncertain and, as more time passes, looks less and less likely. This is particularly important because CHOICE Act 2.0 would only eliminate the Dodd-Frank provision requiring the adoption of the Pay Ratio Rule. It would not result in a repeal of Item 402(u) of Regulation S-K, which would require additional regulatory action to accomplish.

Hedging ‒ Dodd-Frank mandated that the SEC adopt rules requiring companies to disclose whether they allow their directors and employees to engage in hedging transactions related to company securities. The SEC has not yet adopted final rules. Under CHOICE Act 2.0, the SEC would no longer be required to adopt final rules. Many companies have already begun to adopt policies related to hedging transactions; thus, regardless of CHOICE Act 2.0 or other legislation, these policies may become "best practices" for public reporting companies.

Say-on-pay and say-on-pay frequency ‒ Section 14(a) of the Securities Exchange Act of 1934, as amended (Exchange Act), requires public reporting companies to submit to stockholders an advisory vote to approve the executive compensation paid to named executive officers (say-on-pay), and also an advisory vote to determine how often the say-on-pay vote must occur (say-on-pay frequency). CHOICE Act 2.0 would amend Section 14(a) of the Exchange Act to solely require a say-on-pay vote when there is a material change to the executive compensation program; thus, eliminating the say-on-pay frequency vote requirement. Regardless of whether CHOICE Act 2.0 becomes law, we expect that companies will continue to face pressure from stockholders or institutional shareholder organizations, such as ISS, to allow stockholders to provide feedback on a company's executive compensation policies through similar advisory votes or other mechanisms.

Executive compensation clawbacks ‒ Section 10D of the Exchange Act requires national securities exchanges to have listing standards requiring listed companies to "clawback" incentive-based compensation from any current or former executive officer in the event of a financial restatement. CHOICE Act 2.0 would amend Section 10D of the Exchange Act to limit the clawback to those current or former executive officers who had control or authority over the company's financial reporting that resulted in the financial restatement.

Accredited investor status ‒ Dodd-Frank mandated the SEC to increase the dollar thresholds for accredited investor status every four years. CHOICE Act 2.0 would amend Section 2(a)(15) of the Securities Act of 1933, as amended (Securities Act), to create a new statutory definition of "accredited investor" that would fix the income test at $200,000 (or $300,000, including income attributable to a spouse), but would adjust the net worth test, which is currently set at $1 million, for inflation every five years.

Separately, the U.S. House of Representatives passed legislation in February 2017 that would include in the definition of "accredited investor" anyone who is licensed or registered with the SEC as a broker or investment advisor or "whose demonstrable education or job experience qualifies as professional knowledge of a subject related to a particular investment, and whose education or job experience is verified by FINRA or an equivalent self-regulatory organization." Also in February 2017, then-acting Chairman Piwowar called for the SEC to increase investor access to private and risky investment strategies that are usually reserved for wealthy individuals, which could come in the form of a change to the current definition of "accredited investor." The effect of the February 2017 proposed legislation as well as then-acting Chairman Piwowar's statements indicate the desire on the part of some lawmakers to expand the definition of "accredited investor" to allow more individuals to qualify and participate in riskier investments. Conversely, the amendment proposed by CHOICE Act 2.0 signals the desire to continue to limit those individuals who qualify as an "accredited investor."

Conflict minerals ‒ In August 2012, the SEC adopted Rule 13p-1 of the Exchange Act as required by Section 1502 of Dodd-Frank. Rule 13p-1 of the Exchange Act requires public reporting companies that manufacture products containing certain minerals to disclose whether the minerals originated from the Democratic Republic of the Congo (DRC) or any country that shares a border with the DRC. CHOICE Act 2.0 would repeal Section 1502 of Dodd-Frank, as well as Sections 1503 and 1504 of Dodd-Frank requiring disclosure of resource extraction and mine safety.

Prior to the House Financial Services Committee approving CHOICE Act 2.0, in April 2017 the SEC's Division of Corporation Finance issued a public statement that it will not recommend enforcement of the conflicts source and chain of custody due diligence, independent audit, and Conflict Minerals Report requirements set forth in Item 1.01(c) of Form SD, as a result of the April 2, 2017, decision of the U.S. Court of Appeals for the District of Columbia Circuit reaffirming its prior holding regarding the constitutionality of Section 1502 of Dodd-Frank. For more information, please see our prior alert " Conflict Minerals Disclosure – New SEC Guidance." Except as modified by the SEC's April 2017 statement, companies were still required to file Form SDs for the 2016 calendar year. It is unclear, however, whether companies will be required to file Form SDs going forward.

Proxy access rules ‒ Dodd-Frank granted the SEC authority to adopt mandatory proxy access rules. Pursuant to such authority, the SEC adopted Rule 14a-11 under the Exchange Act to give stockholders meeting certain criteria the ability to include director nominees in a company's proxy statement. Litigation regarding the validity of the rule ensued, with the U.S. Court of Appeals for the District of Columbia Circuit ultimately vacating Rule 14a-11.

After the court's decision, the SEC implemented changes to Rule 14a-8, requiring companies to include in their proxy materials stockholder proposals addressing the director nomination process. Under Rule 14a-8, a stockholder who holds 1 percent or $2,000 of the company's voting securities for at least one year and submits a proposal at least 120 days before the anniversary of the previous year's proxy mailing may submit a 500-word proposal for inclusion in the company's proxy statement. Effectively, Rule 14a-8 empowers stockholders to make the decision on proxy access, and the applicable standards, on a company-by-company basis instead of through universally applicable procedures.

CHOICE Act 2.0 would repeal the SEC's authority to issue mandatory proxy access rules. However, this is not expected to impact many companies because they have already adopted proxy access provisions in their bylaws in response to stockholder pressure or as "best practices." We expect companies to continue to adopt these measures regardless of whether the SEC's authority to adopt proxy access rules is repealed.

In addition, CHOICE Act 2.0 would direct the SEC (1) to amend Rule 14a-8 to require a stockholder to hold 1 percent ownership of a company's voting securities for three years (instead of the current $2,000 worth of voting securities for one year) to be eligible to submit a proposal, (2) to increase the required voting success thresholds for resubmission of a stockholder proposal, and (3) to prohibit a company from including in its proxy materials a stockholder proposal submitted by a person in such person's capacity as a proxy, representative or agent. Finally, CHOICE Act 2.0 would amend Section 14 of the Exchange Act to prohibit the SEC from adopting a "universal proxy" ballot in contested director elections.

Disclosure of board leadership structure ‒ Dodd-Frank requires disclosure in annual proxy statements as to why a company chose its current board leadership model. Prior to the enactment of Dodd-Frank, Item 407(h) of Regulation S-K substantially required this disclosure. CHOICE Act 2.0 would repeal the Dodd-Frank provision requiring this disclosure; however, it would not repeal Item 407(h) of Regulation S-K, which would require additional regulatory action to accomplish.

Other notable capital formation provisions contained in CHOICE Act 2.0 are discussed below:

Definition of "general solicitation" ‒ CHOICE Act 2.0 would direct the SEC to revise the definition of "general solicitation" in Regulation D under the Securities Act so that it does not cover advertisements for meetings with issuers sponsored by angel investor groups, venture forums, venture capital associations and certain other entities (as long as the advertisement does not reference a specific securities offering), or apply to the meetings themselves, as long as only specified information about the issuers' securities offerings is presented at the meetings.

Expansion of Form S-3 eligibility ‒ CHOICE Act 2.0 would expand Form S-3 eligibility to include any registrant with listed equity securities, even those registrants that do not meet the $75 million minimum public float requirement.

Extension of state blue-sky preemption ‒ CHOICE Act 2.0 would extend state blue-sky preemption to any security that is listed on a national securities exchange, or tier or segment thereof, as compared with granting blue-sky preemption only to securities listed on the NYSE, NYSE Amex and NASDAQ, and any other national securities exchange whose listing standards are deemed by the SEC to be substantially similar to NYSE, NYSE Amex and NASDAQ.

Registration under Section 12(g) of the Exchange Act ‒ CHOICE Act 2.0 would change the threshold requirement to register under Section 12(g) of the Exchange Act from 500 non-accredited holders to 2,000 and permit companies to deregister once they have fewer than 1,200 holders (as compared with 300).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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