The Financial Choice Act of 2017
Written by: Gideon Mark
On June 8, 2017 the U.S. House of Representative passed on a virtually party-line vote the Financial Choice Act of 2017 (FCA), which is designed to repeal and rollback many of the most important reforms adopted by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Dodd-Frank was enacted in the aftermath of the subprime mortgage crisis of 2007-09 and was crafted with the primary goal of avoiding an encore of that financial disaster. Dodd-Frank made the most significant changes to the regulation of Wall Street since the Great Depression seven decades earlier.
The asserted justification for the FCA is that Dodd-Frank has imposed an undue regulatory burden on banks, and they are suffering as a result. There is very little empirical evidence to support this rationale. Indeed, as noted by Daniel Gross of slate.com, most of the key evidence is to the contrary. The Quarterly Banking Profile maintained by the Federal Deposit Insurance Corporation shows that the banking system in the United States was in deep trouble prior to Dodd-Frank, but it has made a dramatic recovery since then. This is demonstrated by before and after metrics for, among others, the number of failed banks, the number of banks on the FDIC’s “problem list,” the combined assets of the troubled banks, the percent of banks losing money, write-offs of bad loans, and the combined profit of banks regulated by the FDIC. While there are significantly fewer banks now than there were before Dodd-Frank was enacted, that decline is largely attributable to the decisions by smaller institutions that it was fiscally prudent to combine with, or be acquired by, other banks.
The FCA faces an uncertain future in the Senate. Many of the bill’s worst features are unlikely to survive in the upper chamber. But because the FCA is so sweeping, and it attempts to unwind so many different aspects of Dodd-Frank, it is easy to conceive that various highly damaging provisions of the FCA will emerge unscathed in the Senate version of the legislation. One of the worst aspects of the FCA, which has attracted comparatively little attention, is that the bill substantially undercuts the SEC’s authority to protect investors. Melanie Senter Lubin, the Maryland Securities Commissioner, testified before the U.S. House Committee on Financial Services that the FCA, if enacted in its current form, will “expose investors and securities markets to significant, unnecessary risks.” Prominent scholar John C. Coffee, Jr., Professor of Law at Columbia Law School, was even blunter when he testified before the same committee. He concluded that the FCA “will hobble the SEC’s enforcement program” and the cumulative effect of the FCA’s provisions on the SEC “will be devastating.”
How does the FCA undermine the SEC? It does so in at least the following respects. First, it essentially eliminates the SEC’s use of administrative proceedings to resolve civil actions against defendants. The FCA doesn’t bar such proceedings outright, but it grants to defendants the right to move administrative proceedings to federal court, and proceedings that are not moved to court must in the future be resolved by clear and convincing evidence. “Clear and convincing” is considerably more stringent than the current standard of preponderance of the evidence, and, as Professor Coffee has noted, the more exacting standard is usually reserved for situations involving the loss of civil liberties, rather than a monetary judgment. The combined effect of these provisions will be the de facto elimination of SEC administrative enforcement proceedings. While such proceedings are imperfect, they are an essential element in the enforcement arsenal of the cash-strapped SEC. The perennially under-funded SEC lacks the resources to effectively adjudicate all of its enforcement actions in court, where the proceedings are considerably more resource-intensive.
Second, the FCA repeals the SEC’s existing authority to bar individuals from serving as directors or officers of public companies. These D&O bars are another essential element in the SEC’s enforcement toolkit, and their elimination can serve only to undermine investor protection. Third, the FCA statutorily repeals the so-called Chevron doctrine, pursuant to which courts often defer to the SEC’s interpretations of federal securities laws. The Chevron doctrine has been a foundation of the federal judicial system for decades, and its elimination once again will serve to undermine the SEC’s critical function of investor protection. Fourth, the FCA limits the whistleblower awards that can be granted under Dodd-Frank, by barring awards to individuals who were responsible for, or complicit in, the violation of the securities laws for which the whistleblower provided information to the SEC. While the morality of giving whistleblower awards to co-conspirators can be debated, in practice a number of securities fraud violations have been uncovered only by virtue of tips provided by such individuals. Barring awards to co-conspirators will inevitably result in the uncovering of fewer cases of securities fraud. Fifth, the FCA strips the SEC of flexibility to create new theories of liability within an existing rubric, by requiring the agency to issue an approved statement or guidance detailing what is considered unlawful conduct before it brings an enforcement action based on such conduct.
Overwhelmingly, the FCA’s modifications of the SEC’s current authority favor targets of SEC enforcement activity. If these provisions are accepted by the Senate, and they become law, the major loser will be the investing public.