If you are facing the prospect of an enforcement action by the Securities and Exchange Commission – or if you represent someone in that predicament – you ought to be hoping the full House of Representatives and the Senate hurry up and pass the Financial Choice Act of 2017, which zipped through the House Financial Services Committee last week, less than a month after it was re-introduced by committee chair Jeb Hensarling.
The bill proposes sweeping rollbacks of reforms adopted in the 2010 Dodd-Frank Act, from an overhaul of the Consumer Financial Protection Bureau to repeal of the authority of the “too big to fail” Financial Stability Oversight Panel. In that context, the securities enforcement provisions of the proposed law haven’t gotten much attention. But congressional hearing testimony from two critics of the Financial Choice Act – Columbia law professor John Coffee and Maryland Securities Commissioner Melanie Senter Lubin, testifying on behalf of the North American Securities Administrators Association – suggests the bill could severely restrain the SEC’s power. Coffee went so far as to predict the law would “hobble the SEC’s enforcement program,” to “devastating" effect.
I wrote in December about an earlier version of the Financial Choice Act, back when Hensarling’s bill was just considered a leading indicator of President Trump’s eventual enforcement policies. That proposed law never made it to a vote by the full House of Representatives. The new version, however, is reportedly a priority for House Speaker Paul Ryan so it’s worth taking another look at how the bill would change the rules of securities enforcement.
Overwhelmingly, the changes favor targets of the SEC’s attention. The one big exception to that rule is in the SEC’s power to levy penalties. The bill proposes increasing the statutory penalties for violations of securities law, up to double the current limit for the most serious offenses, and triple for repeat violators.
But there’s a catch – and it threatens the sort of megamillion-dollar, post-crash settlements the SEC reached with banks in the mortgage-backed securities market. The Financial Choice Act is designed to steer the SEC away from imposing penalties on corporations and toward bringing actions against individual offenders. That rejiggering, the law said, will enhance deterrence and protect innocent shareholders. To assure compliance with the new enforcement priorities, the bill would require the SEC, in issuing civil penalties, to include a report by its chief economist that the penalized issuer directly benefited from its wrongdoing and that the penalty does not harm the issuer’s shareholders.
Meanwhile, the bill would shift the balance of power between the SEC and those individual offenders it wants the agency to pursue. As you know, Dodd-Frank expanded the SEC’s ability to bring enforcement actions as administrative proceedings before its own judges, rather than civil suits in federal district court. The agency has taken full advantage of that controversial – and potentially unconstitutional – power. According to a report Tuesday by Cornerstone Research, the SEC filed 80 percent of its enforcement actions in the first half of fiscal year 2017 as administrative proceedings, not civil suits.
Under the Financial Choice Act, defendants in SEC administrative proceedings would have the right to demand instead to go to federal district court, where their cases are governed by the Federal Rules of Civil Procedure and not the SEC’s house rules. According to Columbia professor Coffee, that provision threatens to eliminate administrative proceedings as an SEC enforcement tool, since most defendants will opt to move to federal court if only to slow down their cases. “The slower the SEC must go,” Coffee said in his written testimony on the bill, “the more wrongdoers who escape sanctions.”
For targets who opt to stay in administrative proceedings, the Financial Choice Act would raise the SEC’s standard of proof to clear and convincing evidence of wrongdoing – an exacting standard, Coffee said, that is usually reserved for cases in which civil liberties are at stake. The tough new standard “adds another unnecessary obstacle to the SEC’s ability to enforce the federal securities law,” Coffee said.
The bill also puts a crimp in the SEC’s leverage in settlement negotiations by restricting the agency’s ability to threaten automatic disqualification from regulated activities. Under the existing regimen, the SEC has the discretion to waive disqualification, but the Financial Choice Act argues that the system is not as reasonable as it seems. These disqualifications, it says, were not intended to be used as a tool in enforcement proceedings. The bill would allow defendants to take advantage of an exemption to automatic disqualification unless the SEC holds a hearing and determines they are ineligible.
Maryland securities regulator Lubin called the provision “baffling and misguided … contrary to sound public policy and plain common sense.” Why, she asked in her written testimony, would Congress want to make it easier for so-called bad actors to continue to rely on exemptions that enabled their misconduct?
The bill includes some other defendant-friendly provisions, including the denial of SEC bounties to whistleblowers implicated in the misconduct they have reported, and some apparently neutral requirements for the SEC, such as the publication of a manual that spells out the commission’s enforcement policies and practices. The Financial Choice Act also calls for the creation of a new committee to analyze the SEC’s enforcement tactics, which state regulators, according to Lubin’s written testimony, consider a potential threat to the commission’s independence.
It’s impossible to predict which, if any, of the Financial Choice Act’s SEC enforcement provisions will make it into law – but it’s worth pointing out that Representative Hensarling didn’t make any changes in those provisions between his first version of the bill and the version that his committee backed last week. That could be a signal that his fellow members of Congress are not clamoring to protect the SEC’s ability to bring administrative proceedings and use disqualification as a cudgel in settlement talks.
I emailed the SEC for comment on the bill but didn’t hear back.