On June 8, 2017, the House of Representatives passed an amended version of H.R. 10, the Financial CHOICE Act of 2017, or CHOICE Act 2.0, which scales back or eliminates many of the post-crisis financial reforms that were promulgated by the Dodd-Frank Wall Street Reform and Consumer Protection Act including, for example, the Volcker Rule, the authority of the Financial Stability Oversight Council to designate systematically important financial institutions, and the orderly liquidation authority. In addition, CHOICE Act 2.0 proposes a number of capital market reforms directed at easing the regulatory burden on smaller issuers. The passage of CHOICE Act 2.0 represents a significant step towards financial regulatory reform that the Republican leadership has been calling for since the passage of the Dodd-Frank Act.
CHOICE Act 2.0 as passed by the House has evolved since Republican Representative Jeb Hensarling first introduced the bill in 2016 and the House Financial Services Committee passed "version 2.0" of the bill on May 4, 2017. One significant change from to version 2.0 as passed by the Committee was the omission of a provision that would have repealed the "Durbin Amendment." A highly contested provision, the Durbin Amendment limits interchange fees charged in connection with debit cards, and was removed by House Republicans in an effort to obtain the votes needed to pass the legislation through the House.
In light of the bill's many sweeping changes to the current financial regulatory landscape, the prospects of CHOICE Act 2.0 being approved in its current form by the Senate are slim. The Senate is more likely to pursue legislation that is more limited in scope than the current bill.
While CHOICE Act 2.0 covers a broad range of topics, certain core themes, aside from generally revisiting Dodd- Frank Act reforms, emerge from the bill's provisions, including: (1) dramatically curtailing financial regulatory discretion and encouraging transparency in, and oversight over, regulation and supervision; (2) reining in the ability of the Federal Reserve and others to implement the kinds of interventionist measures that were taken at the height of the financial crisis and generally chipping away at Federal Reserve independence; (3) effecting changes with an aim to facilitate smaller company capital formation; (4) repealing many of the public company disclosure requirements mandated by the Dodd-Frank Act and considered by the Republican leadership as outside the scope of the SEC's purview; (5) limiting the impact of regulation on community banks; and (6) encouraging increased coordination among regulatory agencies.
Subsequent to the House passage of CHOICE Act 2.0, the Treasury Department released the first of a series of reports entitled "A Financial System That Creates Economic Opportunities: Banks and Credit Unions," produced in response to the Presidential executive order on core principles for regulating the financial system,1 which directs the Department to examine existing financial regulation and make recommendations to the President on suggested reforms. While CHOICE Act 2.0 and the Treasury Report touch on many similar topics, there are certain notable differences, including:
- While CHOICE Act 2.0 would repeal the Volcker Rule in its entirety, the Treasury Report does not propose the elimination of the Volcker Rule. Instead, the Treasury Report recommends exempting entities with $10 billion or less in assets from the Rule's scope and suggests that regulatory agencies modify certain concepts and defined terms in order to reduce the complexity of the Volcker Rule.
- While critical of the Consumer Financial Protection Bureau, the Treasury Report, unlike CHOICE Act 2.0, would permit the CFPB to continue enforcing against covered persons for unfair, deceptive, or abusive acts or practices, while recommending that the CFPB more clearly define its interpretations of the UDAAP standard. Like CHOICE Act 2.0, the Treasury Report advocates for the elimination of the CFPB's supervisory authority, noting that this authority is duplicative of the supervisory authority of the prudential regulators, and recommends that the CFPB be funded through Congressional appropriations, thereby increasing Congressional oversight of the agency.
- A majority of the recommendations in the Treasury Report are capable of being implemented directly by the various federal financial industry regulators without Congressional action, making many of the recommendations, in theory, less difficult to institute.
Because the Treasury Report recommends reform that is more modest that those that would be enacted by CHOICE Act 2.0, and the Report's recommendations are the product of Treasury's collaborative discussions with regulators, it may be that the reforms implemented by Congress or the regulatory agencies (or both) will be more reflective of the Treasury Report's recommendations rather than CHOICE Act 2.0 provisions. Republican leaders also may choose to pursue adoption of certain financial reforms that can be tied to spending, revenues or deficit reduction through the budget reconciliation process, where changes would require only a majority vote in the Senate. The Congressional Budget Office estimates that enacting CHOICE Act 2.0 would result in a reduction of budget deficits by $33.6 billion, with the majority of such savings resulting from elimination of the orderly liquidation fund and subjecting the CFPB and other agencies to the Congressional appropriations process.
Nevertheless, the passage of CHOICE Act 2.0 represents a major first step towards financial deregulation. CHOICE Act 2.0, together with the Treasury Report, will certainly be influencing the regulatory agenda for the federal financial regulators for the months and years to come. This note highlights the key takeaways of CHOICE Act 2.0. We will continue to track the progress of CHOICE Act 2.0 as it makes its way through Congress.
Title I: Ending "Too Big to Fail"
- Repeal of the Orderly Liquidation Authority. CHOICE Act 2.0 would repeal the orderly liquidation authority ("OLA") created under the Dodd-Frank Act, which enables federal regulatory authorities to place a large financial company into a receivership if its failure under ordinary insolvency law would have a serious adverse impact on US financial stability. In its place, CHOICE Act 2.0 would create a new Subchapter V under Chapter 11 of the Bankruptcy Code, which is tailored to address the failure of large, complex financial institutions. Such proposed legislation is largely consistent with prior versions of proposals seeking to adopt a specialized subchapter of the Bankruptcy Code for large, complex financial institutions.
- FSOC Reforms. Title I would make significant changes to the membership, structure, powers and functions of the Financial Stability Oversight Council ("FSOC"). Specifically, the FSOC's authority to designate a firm as a systemically important financial institution would be repealed, along with all designations previously made. FSOC would also no longer have the authority to designate central counterparty clearinghouses and payment systems as systemically important financial market utilities.
- Elimination of the Office of Financial Research. Title I would eliminate the Office of Financial Research, an independent office that was created within the Department of the Treasury by the Dodd-Frank Act.
- Biannual Resolution Plans. Title I would reduce the frequency of living will submissions to every 2 years and eliminate the role of the Federal Deposit Insurance Corporation ("FDIC") in the process. The Board of Governors of the Federal Reserve System (the "Federal Reserve") would be required to provide feedback to banking organizations within six months of their submissions of the living wills, and to publicly disclose its resolution plan assessment frameworks for notice and comment.
- Reforms Stress Test Regime. Title I would overhaul the current stress testing regime for banking organizations, including extending the Comprehensive Capital Analysis and Review ("CCAR") cycle to every two years, eliminating the Dodd-Frank Act Stress Tests ("DFAST") for banking organizations that are not bank holding companies ("BHCs") and increasing the transparency of the stress testing process.
- Curb Emergency Assistance. Title I would curb the federal regulatory agencies' ability to assist large financial institutions that encounter financial distress. For example, it would repeal the provisions of the Dodd-Frank Act that currently permit the FDIC and the Federal Reserve to create a widely available program to guarantee obligations of solvent financial firms and their affiliates in the event of a liquidity event and limit the use of the Exchange Stabilization Fund ("ESF").
Title II: Demanding Accountability From Wall Street
- Increase Maximum Regulatory Penalties. Title II would increase the maximum penalties that regulators could impose under certain federal laws, including: the Securities Act of 1933 (the "Securities Act"), the Securities Exchange Act of 1934 (the "Exchange Act"), the Investment Advisers Act of 1940 (the "Advisers Act"), the Investment Company Act of 1940 (the "'40 Act"), the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA"), the Home Owners' Loan Act, the Federal Deposit Insurance Act, the Federal Credit Union Act, the Federal Reserve Act, and the Bank Holding Company Act of 1956 ("BHC Act").
Title III: Demanding Accountability From Financial Regulators
- Require Cost-Benefit Analysis. Title III would require federal financial regulatory agencies to conduct quantitative and qualitative cost-benefit analyses when proposing new regulations. Specifically, the agencies could not propose new rulemakings without first analyzing the effectiveness of such rule and its burden on potential stakeholders, especially local entities, governments or private sectors.
- Periodic Review of Regulators. Within one year of enactment of CHOICE Act 2.0 and every five years thereafter, each federal financial regulatory agency2 would be required to submit to Congress and post on their public website, a plan to modify, streamline, expand or repeal existing regulations to make its regulatory program more effective or less burdensome.
- Congressional Approval of Major Rules. Title III requires each "major rule" (as defined within CHOICE Act 2.0) of a federal financial regulatory agency to be approved by a joint resolution of Congress within 70 session days or legislative days of its submission to Congress before it could take effect.
- Eliminate Chevron Deference. Title III would eliminate the so-called Chevron doctrine of judicial deference for federal financial regulatory agencies, under which judges generally defer to an agency's reasonable statutory and regulatory interpretation where a statutory or regulatory provision contains a gap or ambiguity. CHOICE Act 2.0 would implement the repeal two years after enactment rather than immediately, as was stipulated in earlier iterations of the bill.
- Asserting Congressional Control. Title III would bring the FDIC, FHFA, OCC, the examination and supervision functions of the NCUA, and the non-monetary functions of the Federal Reserve into the Congressional appropriations process.
- Requiring Coordination in Enforcement Actions. Title III would require the federal financial regulatory agencies to implement policies and procedures to minimize duplication of efforts with other federal and state authorities when bringing administrative or judicial action against an individual or entity, and establish a "lead agency" for joint investigations, administrative actions or judicial actions.
- Criminalizing Disclosure of Individual Information. Title III would create a misdemeanor offense for any employee of a Federal department or agency who discloses individually identifiable information contained in confidential agency records without authorization.
Title IV: Facilitating Capital Formation for Small Businesses, Innovators and Job Creators
- "JOBS Act 2.0." Title IV is primarily focused on easing the regulatory hurdles of smaller companies related to raising capital and on providing a smoother transition for smaller companies that have completed an initial public offering. Title IV covers a range of areas, including raising the shareholder thresholds triggering public company status, expanding private offering exemptions, delaying the impact of certain requirements of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") and expanding the availability of shelf offerings to smaller companies. Some of the key changes include:
- Eliminating the 500 non-accredited investor threshold triggering registration under Section 12(g), leaving as the Section 12(g) registration triggers $10 million in assets and at least 2,000 holders of record. The SEC would be required to index the $10 million asset trigger for inflation every five years. In addition, the threshold that allows a company to cease reporting as a public company would be increased to fewer than 1,200 shareholders (up from 300).
- Creating a new "micro offering" exemption for offerings of less than an aggregate of $500,000 in a 12-month period, increasing the Regulation A+ offering ceiling to $75 million in a 12-month period (up from $50 million) and revamping the existing crowdfunding rules.
- Revising the definition of "general solicitation" in a private offering to exclude presentations and related advertising for events sponsored by venture capital or angel investor groups, and expanding the exemption for private resales of securities by allowing general solicitation and eliminating information requirements for sales made on accredited investor-only platforms.
Restricting the SEC from adopting some of the investor protections it has proposed to add to certain JOBS Act private offering reforms.
- Allowing all companies, regardless of their size, that are seeking to go public to use the JOBS Act provisions to "test the waters" and make all registration statement filings with the SEC on a confidential basis, with the requirement to file publicly 15 days before the start of the roadshow.
- Delaying the Sarbanes-Oxley Act 404(b) requirement for a company to have its auditor attest and report on management's assessment of internal controls for up to 10 years for companies with revenue of less than $50 million.
- Allowing all companies with listed equity securities, regardless of public float, to conduct shelf offerings on Form S- 3.
- Expanding the availability of well-known seasoned issuers ("WKSI") status, and the related offering communication rules to business development companies and closed-end funds.
- Codifying existing staff position providing an exemption from broker-dealer registration and registration for a category of broker-dealers engaged in advising companies on M&A transactions.
Title V: Relief From Regulatory Burden for Community Financial Institutions
"Ability to Repay" Safe Harbors. Title V makes various revisions to the regulatory framework for residential mortgage lending, including providing a safe harbor from consumers' "ability to repay" requirements that are originated by a depository institution and are maintained in the portfolio of such institution.
- Tailoring to Community Banks. Federal banking regulators would have increased responsibilities and accountability for all future rulemakings, as CHOICE Act 2.0 would require that regulators take into consideration certain factors, such as the necessity, appropriateness and impact of rulemakings, and tailor each rulemaking to limit the regulatory compliance impact, cost, liability risk and other burdens on institutions within their respective jurisdictions. Further, banking agencies would be required to disclose how they have complied with this requirement in each rulemaking release and submit an annual report to Congress regarding their compliance.
- Oversight of Supervisory Functions. An Office of Independent Examination Review would be created within the Federal Financial Institutions Examination Council ("FFIEC"), which would investigate regulators' examination practices and receive petitions from financial institutions for review of supervisory determinations.
- Overturning Madden v. Midland Funding, LLC. The "valid when made" doctrine would be codified, such that the interest rate applicable to a loan would remain valid after a loan is transferred if the interest rate was valid under the laws applicable to the lender at the time the loan was originated, irrespective of whether the loan's interest rate would violate a state usury law applicable to the transferee of such loan.
- FIRREA Actions. The Act would also limit the subpoena power of the Attorney General in investigating possible violations under FIRREA and clarifies the circumstances under which banks may be prosecuted for fraud or related financial crimes under FIRREA.
Title VI: Regulatory "Off Ramp" for Strongly Capitalized, Well-Managed Banking Organizations
- Title VI provides that qualifying banking organizations ("QBOs"), by virtue of maintaining an average leverage ratio of 10%, would become exempt from various federal laws and regulations, including: (i) all capital and liquidity requirements, (ii) all laws and regulations that would permit federal banking agencies to object to a capital distribution, including CCAR, (iii) consideration by federal banking agencies of financial stability-related factors in connection with certain events and applications (e.g., examinations and applications relating to M&A), (iv) the deposit concentration limit, (v) certain limitations on large acquisitions made by banking holding companies and financial holding companies, and (vi) certain "enhanced prudential standards" established by Section 165 of the Dodd-Frank Act (e.g., living wills, stress testing and single counterparty credit limits). Notably, few large banks would be able to satisfy the capital standards required to become QBOs today without raising more capital.
Title VII: Consumer Financial Protection Bureau
- Reforming CFPB's Structure. Title VII introduces a series of reforms to the Consumer Financial Protection Bureau (the "CFPB"). The CFPB would be renamed the "Consumer Law Enforcement Agency" and while it would still be led by a single Director, the President would now be able to remove the Director at will. Additionally, the President, rather than the Director, would be able to appoint the agency's Deputy Director. A Senate-confirmed inspector general would also be created for the agency.
- The agency would no longer be funded through the Federal Reserve System and instead would receive funding through the Congressional appropriations process.
- CFPB Limited to Enforcement. The CFPB would be stripped of its supervisory and examination powers, but retain its enforcement authority, although such authority would be reduced. The CFPB would lose its ability to promulgate and enforce rules addressing unfair, deceptive, or abusive acts and practices by financial institutions, and the ability to limit or prohibit the use of arbitration agreements where they violate public interest. The CFPB would no longer be responsible for regulating small dollar credit, including payday and vehicle title loans. Its complaint database would no longer be made publicly available.
Status of Durbin Amendment. While the bill that originally passed the Committee contained a provision that would repeal the Durbin Amendment, which limits fees charged in connection with debit cards, House Republicans removed this repeal from the bill before the full House vote.
Title VIII: Capital Markets Reform
- Title VIII of CHOICE Act 2.0 covers amendments to a wide range of areas from SEC funding and appropriations to its internal operations and functioning. It also makes specific changes to the powers, policies and procedures of the Enforcement Division, changes to the regulation of rating agencies and changes to corporate governance practices. Finally, Title VIII repeals a range of the Dodd-Frank Act rulemaking mandates and directives to conduct studies and prepare reports. Some of the key changes include:
- Significant changes to enforcement, including limiting the SEC's ability to seek relief through administrative proceedings, mandated presentations and notifications to the SEC following Wells notices, providing for limitations on the duration of investigations and for timely notices of the closing of investigations, creating an "enforcement ombudsman" with confidential communication procedures, elimination of automatic disqualification of exemptions, and the requirement that an updated enforcement manual be published with priorities and trends.
- Eliminating compensation for whistleblowers who were responsible for or complicit in misconduct.
- Changing the pleading standards in connection with derivative suits against investment companies.
- Repealing the Department of Labor's "fiduciary rule."
- Significant changes to the shareholder proposal rules, including increasing the stock ownership thresholds necessary to submit shareholder proposals to be voted on at annual shareholders meetings, increasing the stock ownership thresholds necessary for shareholders to resubmit proposals that were voted down at prior annual meetings and allowing companies to exclude shareholder proposals submitted on behalf of shareholders.
- Prohibiting the SEC from adopting a rule that provides that a company must use a single ballot in connection with a contested election for its board of directors.
- Fixing the income test of the accredited investor definition at $200,000 per year (or $300,000 including spouse's income) and the net worth test to $1 million. Each test would be adjusted for inflation every five years.
- Eliminating the Sarbanes-Oxley Act 404(b) requirement to have an auditor attest and report on management's assessment of internal controls for companies with a market cap of less than $500 million (from $75 million).
- Repealing the conflict minerals, resource extraction and mine safety disclosure requirements.
- Repealing the Dodd-Frank Act provisions related to pay ratio, hedging disclosures and restrictions on incentive compensation at certain financial institutions, and restricting the scope of the proposed compensation claw back rule.
- Requiring the CFTC and SEC to review and harmonize swaps and security-based swaps rules.
Title IX: Repeal of Volcker Rule
- Title IX would repeal Section 619 of the Dodd-Frank Act, commonly known as the Volcker Rule, in its entirety.
Title X: Federal Reserve Reform and Emergency Lending Authority
- Reforming the Monetary Function. In an effort to increase transparency and predictability of the process of the Federal Reserve regarding monetary policy, Title X would establish a rule-based process by which the Federal Open Markets Committee ("FOMC") would set interest rates. The bill would also provide for the Comptroller General to perform an annual audit of the Federal Reserve and the Federal Reserve Banks. FOMC meetings would also be recorded, with transcripts being made publicly available. Additionally, a Centennial Monetary Commission would be established and tasked with reviewing the operation, history and impact of the Federal Reserve's monetary policy on the economy and making certain related legislative recommendations.
- Limiting the Emergency Authority. Title X would limit the Federal Reserve's emergency lending authority under Section 13(3) of the Federal Reserve Act by: (i) only permitting emergency lending in unusual and exigent circumstances "that pose a threat to the financial stability of the United States," (ii) adding to existing approval requirements for emergency lending, the approval of at least nine Federal Reserve Bank presidents, (iii) revising collateral requirements to, among other things, prohibit the acceptance of equity collateral, (iv) requiring regulatory certification of an institution's solvency, and (v) establishing a minimum interest rate for loans made under this authority.
Title XI: Insurance Reform
- Title XI would abolish the Federal Insurance Office and create instead, the Office of Independent Insurance Advocate within the Treasury Department, with the head of the new Office being the independent member with insurance expertise on the FSOC. The Office would not have general supervisory or regulatory authority over the business of insurance, thereby preserving the traditional state-based system of insurance regulation in the United States.
1 For an overview of the Presidential executive order, you may wish to refer to our client publication: "An Annotated Guide to Trump's Executive Order on Financial Regulatory Reform," available at: http://www.shearman.com/en/newsinsights/publications/2017/02/guide-to-trump-order-on-financial-reg-reform
2 Federal financial regulatory agencies for purposes of Title III are: the Federal Reserve, CFPB, Commodity Futures Trading Commission ("CFTC"), FDIC, Federal Housing Finance Agency ("FHFA"), Office of the Comptroller of the Currency ("OCC"), National Credit Union Administration ("NCUA") and Securities and Exchange Commission ("SEC").
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