Financial CHOICE Act Approved by House | Practical Law

Financial CHOICE Act Approved by House | Practical Law

The US House of Representatives passed the Financial CHOICE Act of 2017 (H.R. 10). The CHOICE Act would make significant financial regulatory changes including the repeal or replacement of certain key provisions of the Dodd-Frank Act.

Financial CHOICE Act Approved by House

Practical Law Legal Update w-008-5901 (Approx. 16 pages)

Financial CHOICE Act Approved by House

by Practical Law Finance
Published on 14 Jun 2017USA (National/Federal)
The US House of Representatives passed the Financial CHOICE Act of 2017 (H.R. 10). The CHOICE Act would make significant financial regulatory changes including the repeal or replacement of certain key provisions of the Dodd-Frank Act.
On June 8, 2017, the US House of Representatives, in a 233-186 vote, passed the Financial CHOICE Act of 2017 (the CHOICE Act, also referred to as "CHOICE" or the "Act"). The bill will now be considered by the Senate.
The CHOICE Act would make significant changes to US financial regulation, including the repeal or replacement of certain key provisions of the Dodd-Frank Act such as the Volcker Rule. The CHOICE Act would also rename and restructure the Consumer Financial Protection Bureau (CFPB) and repeal the controversial Department of Labor (DOL) fiduciary rule.
The CHOICE Act was first released in the summer of 2016 (see Legal Updates, Potential Impact of 2016 US Presidential Election on Financial Services Regulation). Proponents of the CHOICE Act assert that it would provide for a regulatory landscape that is focused on economic growth through competition and capital markets.
Key provisions of the CHOICE Act would:
The CHOICE Act will now be considered by the Senate, though it is likely that alternative legislation will be introduced proposing a more limited approach to financial reform than CHOICE currently proposes. On June 12, 2017, US Treasury Secretary Mnuchin issued a report containing regulatory reform recommendations that already suggest a more scaled-back approach (see Legal Update, US Treasury Issues Regulatory Reform Recommendations for Depository Institutions).

Qualifying Capital Election

The CHOICE Act proposes to permit large banking organizations that maintain a leverage ratio of capital to assets of at least 10 percent to obtain an exemption from certain regulatory requirements. This 10 percent leverage ratio would be higher than the present leverage ratio requirements of:
  • Three percent for large banks under Basel Committee rules; and
  • Six percent for G-SIBs under US banking regulations.
The CHOICE Act intends for this to be an "off-ramp" from Dodd-Frank for strongly capitalized, well-managed banking organizations if these organizations maintain higher capital than required by current regulations.
Regulations that these large banking organizations can elect to be exempt from include:
In addition, under the CHOICE Act, banking agencies would be permitted to conduct stress tests but would not be permitted to limit capital distributions (see Practice Note, Summary of the Dodd-Frank Act: Regulation of Systemically Significant Financial Institutions: Other Authorities of the FRB: Stress Tests).

Volcker Repeal

The CHOICE Act also proposes to repeal the Volcker Rule, or Section 619 of the Dodd-Frank Act, which prohibits US bank holding companies (BHCs) and certain insured depository institutions from engaging in "proprietary trading" and from acquiring or retaining any ownership interest in, or sponsoring, a hedge fund or a private equity fund (see Practice Note: Summary of the Dodd-Frank Act: The Volcker Rule). The CHOICE Act proposes to eliminate this prohibition in its entirety.

Repeal of DOL Fiduciary Duty Rule

On April 6, 2016, the DOL issued a final fiduciary rule with an applicability date of April 10, 2017 (see Fiduciary Investment Advice Toolkit). The final fiduciary rule defined the term "fiduciary" for broker-dealers and investment advisers providing advice to participants and beneficiaries of employee benefit plans governed by the Employee Retirement Income Security Act of 1974 (ERISA) and individual retirement accounts (IRAs).
On April 4, 2017, the DOL issued a final rule that delayed by 60 days the applicability of the fiduciary investment advice regulation that replaces the existing regulatory interpretation of fiduciary investment advice under Section 3(21)(A)(ii) of ERISA and the related prohibited transaction exemptions (see DOL Issues Final Rule Delaying Applicability Date of Fiduciary Rule and Related Prohibited Transaction Exemptions).
The fiduciary rule and related exemptions are now applicable (as of June 9, 2017), while compliance with the remaining conditions in these exemptions, including the requirements to execute the best interest contract and make specific written disclosures and representations of fiduciary compliance in communications with investors, is not required until January 1, 2018.
The CHOICE Act attempts to repeal the fiduciary rule and stop the DOL from issuing the rule until the SEC issues its own rule on standards of conduct for broker-dealers and investment advisers (SEC Rule). The CHOICE Act further requires the SEC, before issuing the SEC Rule, to provide reports to Congress on:
  • The potential harm to retail investors resulting from the rule.
  • Alternative remedies.
  • Whether a uniform fiduciary standard for broker-dealers and investment advisers would have an adverse impact on commissions, product availability, as well as transaction abilities for broker-dealers and access to investment advice for retail investors.
The CHOICE Act also indicates that any DOL fiduciary rule must substantially conform to the SEC's standards.
Given that the DOL fiduciary rule became partially applicable on June 9, 2017, it is unlikely that the CHOICE Act will immediately impact the fiduciary rule.
However, because many of the more onerous requirements of the fiduciary rule do not become applicable until January 1, 2018, and the CHOICE Act would require the rule to be substantially similar to the SEC Rule, the CHOICE Act casts further doubt on whether the fiduciary rule as currently drafted will ever ultimately become fully applicable.

Repeal of ABS Risk Retention Rules

The CHOICE Act would also provide a complete repeal of Dodd-Frank ABS risk retention rules for all classes of ABS other than RMBS. Under Dodd-Frank risk retention rules, securitizers, including sponsors of ABS transactions, must retain five percent of the credit risk of an ABS transaction, a rule that is designed to align the interests of securitizers with those of ABS investors (see Practice Note, ABS Risk Retention under Dodd-Frank).
However, the LSTA and other industry groups have been pressing regulators to create exemptions from the risk retention rules for certain asset classes that have performed well historically – most notably for certain qualified CLO transactions, or QCLOs (see Practice Note, ABS Risk Retention under Dodd-Frank: LSTA Lawsuit and Other CLO Risk Retention Reform Efforts). The LSTA also recently submitted letters to Treasury and Congress seeking the elimination of the ABS risk retention requirements for CLO managers (see Legal Update, LSTA Submits Letter to Treasury Seeking Reform of Risk Retention Rules for CLO Managers).
The CHOICE Act would eliminate the risk retention rules entirely for ABS other than for securitizations of residential mortgages, for which the rules would remain effective.

Repeal of FDIC Orderly Liquidation Authority (OLA) and FSOC SIFI Designation

The CHOICE Act proposes to repeal Title II of the Dodd-Frank Act, which establishes the FDIC's non-bank Orderly Liquidation Authority (OLA). The OLA authorizes the FDIC to facilitate the liquidation of failing financial companies in certain circumstances and was intended as a solution to taxpayer-funded bailouts (see Practice Note, Summary of the Dodd-Frank Act: Resolution of Failing Financial Institutions: Orderly Liquidation Authority).
The CHOICE Act would also repeal the FSOC's authority to designate non-bank firms as SIFIs and its authority to designate systemically important financial market utilities (SIFMUs). It would also repeal Dodd-Frank's "Hotel California Rule," which automatically makes any BHC a SIFI if it has more than $50 billion in consolidated assets.
Instead, the CHOICE Act proposes a new Subchapter V within Chapter 11 of the Bankruptcy Code to accommodate the failure of large financial institutions, incorporating legislation from the Financial Institution Bankruptcy Act of 2017 (H.R. 1667) (FIBA), which was passed by the House on April 5, 2017. This subchapter would provide for the liquidation, reorganization, or recapitalization of BHCs and SIFIs ("covered financial corporations") and would include requirements for:
  • Commencement of the bankruptcy case.
  • Appointment of a special trustee.
  • Procedure for expedited transfer of assets.
  • Treatment of qualified financial contracts (QFCs), affiliate contracts, licenses, permits, and registrations.
  • Exemption from US securities laws.
  • Disapplication of certain avoiding powers.
  • Considerations of financial stability.

CFPB Restructuring

The CHOICE Act proposes to rename and restructure the CFPB, established under Title X of Dodd-Frank, to limit its supervision and enforcement authority and to instead function similarly to the Federal Trade Commission (FTC).
Under the CHOICE Act, the CFPB would become the Consumer Law Enforcement Agency (CLEA) with a director removable by the president at will and subject to the congressional appropriations process for additional oversight and accountability. The CLEA would also be subject to the authority of the Office of Information and Regulatory Affairs (OIRA), similar to a non-independent regulatory agency.
The CHOICE Act proposes significant changes to the functioning and rulemaking process of the agency. Some of the notable changes include:
For background on CFPB headwinds under the Trump Administration, see Legal Update, CFPB Continues to be Target for Potential Elimination.

Fed Reform

The CHOICE Act proposes to decrease the Fed's regulatory and supervisory powers and subject the Fed to greater congressional oversight and accountability, including:
  • Subjecting it to a comprehensive audit conducted by the Government Accountability Office (GAO).
  • Reforming its living will requirements for banking organizations that do not make a qualifying capital election.
  • Reforming its stress-test procedures.
  • Establishing a more "transparent and reliable" monetary-policy strategy.
Living wills and stress tests for major financial institutions conducted by the Fed are provided for under Section 165 of the Dodd-Frank Act, which permits the Fed to oversee the activities of SIFIs. For more information, see Summary of the Dodd-Frank Act: Regulation of Systemically Significant Financial Institutions.

Impact on SEC Authority and Operations

The CHOICE Act proposes to increase penalties for securities laws violations, in part through reforms to the SEC's enforcement program. Under the CHOICE Act, the SEC's civil penalty authority would be increased, and criminal sanctions under the federal securities laws for serious offenses including insider trading would be enhanced.
In addition, the CHOICE Act would require the SEC to "holistically" review its enforcement program, incorporate economic analysis into its deliberations on enforcement matters, and augment the rights of individuals under SEC investigation to defend themselves, including a right of removal to federal court.
However, the CHOICE Act would also update the SEC's structure and organization by:
  • Reauthorizing the SEC for a period of five years, subject to appropriations.
  • Requiring the SEC to implement the recommendations from the March 2011 report from independent consultant Boston Consulting Group (BCG) regarding the SEC's internal operations and structure.
  • Updating several of the SEC's divisions and offices.
  • Requiring the SEC to establish an advisory committee on SEC enforcement policies and practices.
In addition, the CHOICE Act would also restrict SEC operations, including by:
  • Requiring any SEC statement or guidance, including interpretive rules, general statements of policy, or SEC rules of organization, procedure, or practice, that has the effect of implementing, interpreting, or prescribing law or policy, be subject to notice and comment periods.
  • Repealing the SEC's authority to prohibit individuals found to have violated Securities Act or Exchange Act rules or regulations from serving as officers or directors of reporting companies.
  • Prohibiting the SEC from requiring universal ballots or proxies for contested director elections.
  • Repealing the SEC's authority to require proxy access (see below).
  • Requiring the SEC to monitor proxy advisory firms and publish an annual report covering, among other things, an evaluation of proxy advisory services provided and conflicts of interest among the firms.

Repealing Dodd-Frank Specialized Disclosure Requirements

The CHOICE Act includes a repeal of:
  • Section 1502 of the Dodd-Frank Act, which provides the statutory authority for the SEC's conflict minerals rule.
  • Section 1503 of the Dodd-Frank Act, which provides the statutory authority for the SEC's rule on mine safety disclosure.
  • Section 1504 of the Dodd-Frank Act, which provides the statutory authority for the SEC's rule on resource extraction payments.

Conflict Minerals

Section 1502 of the Dodd-Frank Act directs the SEC to adopt rules requiring SEC reporting companies to conduct diligence and make certain disclosures concerning specific minerals contained in the companies' products (conflict minerals).
On August 22, 2012, the SEC adopted a final rule implementing Section 1502, Rule 13p-1 under the Exchange Act , which requires companies to conduct conflict minerals diligence and file reports on Form SD regarding their products that contain conflict minerals. Companies have been reporting conflict minerals information since 2014, although business groups challenged the conflict minerals rule in federal court in 2012, and ultimately the US Court of Appeals for the DC Circuit struck down one disclosure provision of the rule.
The CHOICE Act would completely repeal Section 1502.
For more information on the conflict minerals rule, see Conflict Minerals Rule Compliance Toolkit.

Mine Safety

Section 1503 of the Dodd-Frank Act directs the SEC to adopt rules requiring SEC reporting companies that operate (or own a subsidiary that operates) a coal or other mine to include in their periodic reports additional health and safety information for each of their mines and file reports on Form 8-K to disclose receipt of imminent danger orders and written notices from the Mine Safety and Health Administration of patterns of violations.
On December 21, 2011, the SEC adopted final rules to implement the mine safety disclosure requirements. The final rules adhere closely to the provisions of the Dodd-Frank Act. Companies have been reporting mine safety information since 2012.
The CHOICE Act would completely repeal Section 1503.

Resource Extraction Payments

Section 1504 of the Dodd-Frank Act directs the SEC to adopt rules requiring SEC reporting companies that are engaged in the commercial development of oil, natural gas, or minerals to disclose in their annual reports additional information about payments to foreign governments for resource extraction.
On August 22, 2012, the SEC adopted rules implementing the resource extraction provision. On July 2, 2013, the US District Court for the District of Columbia vacated Rule 13q-1, which would have required resource extraction issuers to file a Form SD report publicly disclosing certain payments to foreign and US federal and state governments, and remanded back to the SEC for further proceedings. On June 27, 2016, the SEC adopted new final rules implementing disclosure requirements for resource extraction issuers.
In February 2017, Congress passed a joint resolution to disapprove the SEC's resource extraction rule and declare it to have no force or effect, which was signed into law by the President on February 14, 2017 (see Legal Update, House and Senate Approve Joint Resolution to Disapprove the SEC's Resource Extraction Rule) .
The CHOICE Act would completely repeal Section 1504.

Eliminating or Modifying Certain Dodd-Frank Executive Compensation and Corporate Governance Requirements

The CHOICE Act would amend certain Dodd-Frank executive compensation requirements:
  • Say on pay. The CHOICE Act would amend Section 14A of the Exchange Act to require a shareholder advisory vote on executive compensation only when there has been a material change to executive compensation from the previous year (as opposed to no less frequently than once every three years under this section currently).
  • Frequency of say on pay. The CHOICE Act would amend Section 14A of the Exchange Act to eliminate the need for reporting companies to hold a shareholder advisory vote on how frequently to conduct a say on pay vote.
  • Clawbacks. The CHOICE Act would amend Section 10D of the Exchange Act to require listed companies to adopt a policy for recoupment of executive incentive compensation if an accounting restatement is required due to material noncompliance with any financial reporting requirements that would apply only to those executive officers that had control or authority over the financial reporting that resulted in the restatement (as opposed to any current or former executive officer that received incentive compensation in the three-year period before the date the restatement is required under this section currently).
For more information on the existing Dodd-Frank requirements and their status, see Practice Note, Summary of the Dodd-Frank Act: Executive Compensation.
In addition, the CHOICE Act would completely repeal the following requirements imposed by the Dodd-Frank Act:
  • Section 953(b): pay ratio.
  • Section 955: disclosure of insider hedging.
  • Section 956: enhanced executive compensation structure reporting by covered financial institutions.
  • Section 971: SEC's authority to mandate proxy access.
  • Section 972: disclosure of chairman of the board and CEO leadership structure.

Pay Ratio

Section 953(b) of the Dodd-Frank Act requires reporting companies (other than EGCs) to disclose the median of annual total compensation of all employees, excluding the CEO; the annual total compensation of the CEO; and a ratio of the median employee annual total compensation to the CEO's annual total compensation.
On August 5, 2015, the SEC adopted a final rule amendment to Item 402 of Regulation S-K that would require companies to disclose this pay ratio information, with explanatory narrative disclosure accompanying the pay ratio. Reporting companies must begin making pay ratio disclosure for the first fiscal year that begins on or after January 1, 2017. Therefore, a company with a December 31 fiscal year end would be required to make the disclosure for fiscal year 2017 in its Form 10-K for 2017 due in 2018 or the proxy or information statement for its 2018 annual meeting.
The CHOICE Act would completely repeal Section 953(b).

Disclosure of Insider Hedging

Section 955 of the Dodd-Frank Act requires reporting companies to disclose whether any of their employees and directors is allowed to hedge against losses on their company stock (including stock received as part of compensation). On February 9, 2015, the SEC proposed a rule implementing the Dodd-Frank hedging disclosure requirement.
The CHOICE Act would completely repeal Section 955.

Enhanced Compensation Structure

Section 956 of the Dodd-Frank Act requires the National Credit Union Administration (NCUA), the FDIC, the Federal Housing Finance Agency, the Board of Governors of the Federal Reserve System, the OCC, and the SEC to jointly prescribe rules requiring covered financial institutions to disclose to the appropriate regulator the structures of their incentive-based compensation arrangements offered to determine whether they provide excessive compensation or that could lead to a material financial loss.
On April 21, 2016, the NCUA proposed rules on incentive compensation for financial institutions implementing this requirement, and on May 6, 2016, the other federal agencies agreed to a joint rule proposal.
The CHOICE Act would completely repeal Section 956.

Easing Capital Formation Requirements

The CHOICE Act proposes a series of capital formation provisions that would aim to assist small- and medium-sized businesses to more easily raise capital and comply with ongoing requirements of reporting companies under the Exchange Act (in addition to repealing or amending Dodd-Frank requirements as described above), including measures to:
  • Expand certain provisions of the JOBS Act, including liberalizing shareholder thresholds under the Exchange Act, testing the waters and confidential submissions under the Securities Act and scaled requirements for emerging growth companies, as well as amendments to crowdfunding rules and Regulation A+.
  • Eliminate certain regulatory burdens on small companies, including exemption from XBRL requirements, expanding the auditor attestation report exemption in Section 404 of Sarbanes-Oxley and expanding eligibility for use of Form S-3.
  • Modernize regulations for business development companies (BDCs) (see Practice Note, Business Development Companies).
  • Create venture exchanges to trade securities of early-stage, growth companies exempt from registration under Section 3(b) of the Securities Act.

Increasing Administrative Accountability

Appropriations and economic analysis. The CHOICE Act would:
  • Apply the provisions of the Regulations from the Executive in Need of Scrutiny (REINS) Act (H.R. 26) to provide for congressional oversight of certain major economic or financial regulations.
  • Require financial regulators to conduct economic analysis before issuing rules.
  • Subject financial agencies to funding through the congressional appropriations process.
Chevron Doctrine. The CHOICE Act would also repeal the Chevron doctrine, which provides a two-part test for judicial review of federal agency actions in which courts must defer to agency interpretations in the case of ambiguity (note that this applies to the SEC as well as federal banking agencies). See Chevron USA Inc. v. Natural Resources Defense Council, Inc., 467 US 837 (August 16, 1984). The CHOICE Act would statutorily repeal Chevron to permit judicial review of agency decisions without the deference to agency interpretations.
Elimination of OFR. The CHOICE Act would also eliminate the Office of Financial Research (OFR), which was created under Title I of Dodd-Frank as a department within the US Treasury that supports FSOC through the collection of data and analysis on risk measurement (see Practice Note, Summary of the Dodd-Frank Act: Regulatory Structure: OFR).

Codification of Valid-When-Made Rule

The CHOICE Act would introduce an amendment to the National Bank Act, the Home Owners' Loan Act, the Federal Credit Union Act, and the Federal Deposit Insurance Act (FDIA) to provide that the interest rate of a loan remains valid regardless of the sale, assignment, or transfer of the loan.
This provision would override the controversial ruling in Madden v. Midland Funding, LLC, in which the Second Circuit held that the National Bank Act does not preempt state usury laws when a non-national bank entity purchases debt from a national bank (see Legal Update, Midland Funding v. Madden: Supreme Court Denies Certiorari in Debt-Purchase Usury Case). This case has caused uncertainty among secondary loan markets and Second Circuit securitizations regarding interest rates for debt purchasers that are not national banks.