Cooley Explains How Dodd-Frank May Come Under Fire

With Congress and the Presidency soon in Republican control, look for the Financial CHOICE Act (or perhaps an enhanced version) to be re-introduced in the next Congress.  The bill, sponsored by Jeb Hensarling, Chair of the House Financial Services Committee, was framed as a Republican proposal to reform the financial regulatory system necessary to undo the burdens of Dodd-Frank, which were characterized as distractions from the SEC’s basic statutory responsibilities. In addition to taking aim at much of Dodd-Frank, among other things, the bill places a heavier burden on proxy advisory firms, regulators and regulations generally and eases some other regulations. Although the bill was never expected to make much progress this year, the NYT suggested that the bill may “help shape the Republican agenda in the next term.” The bill’s chances of becoming law have, well,… to say that they have substantially improved doesn’t quite do the situation justice. In an interview with the WSJ on November 11, Hensarling said “that he planned to make the bill… his top priority next year.” Of course, the Congress may decide to just take a hatchet to Dodd-Frank and various other statutes and rules altogether. Or, alternatively, the Senate Dems could filibuster the Senate version of the bill, or threaten to do so, which could lead to some negotiation. But if the Financial CHOICE Act is signed into law in substantially the same form, the question then is: will we see more private ordering? Will governance activists begin to submit shareholder proposals for, e.g., pay-ratio and hedging disclosures? Will some companies continue a form of conflict minerals compliance on their own initiatives?

Here are summaries of some key (non-bank-related) provisions of Dodd-Frank that would come under fire in the Financial CHOICE Act:

SEC. 443. FREQUENCY OF SHAREHOLDER APPROVAL OF EXECUTIVE COMPENSATION. Amends the Securities Exchange Act of 1934 to require say-on-pay votes only in those years “in which there has been a material change to the compensation of executives of an issuer from the previous year.”  Eliminates the say-on-frequency vote.

SEC. 447. RESTRICTION ON RECOVERY OF ERRONEOUSLY AWARDED COMPENSATION. Amends the Exchange Act to change the Dodd-Frank no-fault clawback for erroneously awarded compensation to apply only where the “executive officer had control or authority over the financial reporting that resulted in the accounting restatement.” 

SEC. 449. REPEALS. Repeals a slew of Dodd-Frank provisions, including pay-ratio disclosure, employee and director hedging disclosure, the authorization of the SEC to adopt proxy access rules and board leadership structure disclosures.

SEC. 455. REPEALS. Repeals another slew of Dodd-Frank provisions, including Section 1502, conflict minerals (even as environmental and human rights organizations are pressing regulators to add cobalt to the conflict mineral list, see this article); Section 1503, mine safety disclosure; and Section 1504, disclosure of payments by resource extraction issuers.

SideBar: The discussion accompanying the bill provided by the Republican House proponents argued that “[s]ince 2010, the SEC has devoted thousands of man-hours and millions of dollars to finish rules mandated by the Dodd-Frank Act that neither address the causes of the financial crises nor advance the SEC’s statutory mission. For example, rather than devote time and resources to rules that would protect investors or facilitate capital formation, the SEC has instead focused its efforts on rules to require public companies to make confusing and immaterial disclosures relating to, for example, conflict minerals, resource extraction, and CEO pay ratios. The Dodd-Frank Act has accelerated a troubling trend in which the securities laws have been hijacked by those more interested in scoring political points than enhancing capital markets or investor protection….As an initial matter, Dodd-Frank’s conflict minerals provisions are explicitly designed to achieve foreign policy objectives, and bear no relation to the underlying purpose of the securities laws, which is to protect investors by providing them with information that is material to their investment decisions, and promote the formation of capital. Indeed, by imposing enormous compliance costs on public companies, Section 1502 impedes the ability of those firms to innovate, grow, and create jobs, while at the same time lowering the returns they can offer their investors.”  The bill’s proponents also contended that the law has actually been harmful to the region: “Section 1502’s constitutional and procedural deficiencies have been compounded by the damage it has done to the citizens of Central Africa, the very region it purports to help. Critics, many from the region itself, argue that Section 1502 has led to a de facto embargo on the region’s minerals, further impoverishing Africans while leaving local militias unaffected….In addition to the harm inflicted on Africans, research has shown that the SEC’s rule has not illuminated companies’ sourcing of conflict minerals to any meaningful degree. According to the GAO, initial company disclosures revealed little: 67 percent of companies reported not being able to determine their minerals’ country of origin, and another 3 percent did not provide a clear determination. No company in GAO’s sample could determine whether its minerals financed armed groups.” (Note that there is widespread disagreement about whether the rules have harmed the region.  See, for example, this PubCo post.)

Below are summaries of several provisions that affect, in some cases dramatically, regulators and the regulatory process:

 SEC. 612. REQUIRED REGULATORY ANALYSIS. Requires specified federal agencies, including the SEC, to conduct an elaborate prescribed cost-benefit analysis before issuing certain notices of proposed or final rulemaking, including data from various commenters (during a 90-day comment period), and prohibits publication of a notice of final rulemaking if the agency, in its analysis, determines that the quantified costs are greater than the quantified benefits.  Requires the SEC to develop plans to subject the PCAOB and the exchanges to these requirements.

SEC. 616. RETROSPECTIVE REVIEW OF EXISTING RULES. One year after adoption, and every five years thereafter, the agencies, including the SEC, would be required to review rules adopted to see if they could be made more effective or less burdensome in achieving the regulatory objectives.

SEC. 617. JUDICIAL REVIEW. During the first year after adoption, an aggrieved person could bring an action for judicial review of the rule, and the court could stay effectiveness of the rule.

SEC. 631. CONGRESSIONAL REVIEW. If the agency classified a rule as “major,” according to specified criteria, the rule would require a joint resolution of Congress to go into effect, unless the President finds that an emergency requires that it be effective (for 90 days). Congress would also have the right to disapprove certain non-major rules. 

SEC. 641. SCOPE OF JUDICIAL REVIEW OF AGENCY ACTIONS.  In any action for judicial review of agency action (including action by the SEC) authorized under any provision of law, the reviewing court shall determine the meaning or applicability of the terms of an agency action and decide de novo all relevant questions of law, including the interpretation of constitutional and statutory provisions, and rules made by an agency. 

SideBar:  This provision appears to represent an effort to repeal by statute the so-called “Chevron doctrine.” That is a reference to the well-worn two-step test for determining whether deference should be accorded to federal administrative agency actions interpreting a statute, first articulated by SCOTUS in 1984 in Chevron v. Natural Resources Defense Council. The discussion accompanying the draft bill describes the doctrine established in that case as mandating that, if there is ambiguity in how to interpret a statute, courts must accept an agency’s interpretation of a law unless it is arbitrary or manifestly contrary to the statute. For example, in a decision released on June 14, Monica Lindeen v. SEC, the D.C. Circuit applied Chevron to uphold the SEC’s rules adopted under Reg A+ against a challenge by two state securities regulators.  And, as another example, the D.C. District Court applied Chevron in initially upholding the SEC’s conflict minerals rules in 2013 in Nat’l Ass’n of Mfrs. v. SECNational Association of Manufacturers v SEC, which was subsequently reversed on other grounds. If adopted, this type of provision could facilitate the types of regulatory challenges frequently mounted by the U.S. Chamber of Commerce, Business Roundtable and others. Of course, with Republicans populating the highest levels of the rule-making agencies, this provision may no longer have the same urgency.

Below are summaries of some of other provisions of the Financial CHOICE Act:

SEC. 445. SMALL ISSUER EXEMPTION FROM INTERNAL CONTROL EVALUATION. Amends Section 404(c) of the Sarbanes-Oxley Act of 2002 to exempt from SOX 404(b) (the requirement to have an auditor attestation and report on management’s assessment of internal control over financial reporting) any issuer with a total market cap of less than $250 million (up from the current threshold of $75 million in public float) and any depository institution with assets of less than $1 billion.

SEC. 1006. INCREASED THRESHOLD FOR DISCLOSURES RELATING TO COMPENSATORY BENEFIT PLANS.  Generally, Rule 701(e) requires an issuer to provide certain disclosures to an investor if the aggregate sales price or amount of securities sold under the Rule during any consecutive 12-month period exceeds $5 million.  This provision would require the SEC, within 60 days after enactment, to raise the Rule 701(e) cap from $5 million to $10 million, indexed for inflation every five years to reflect the change in the Consumer Price Index for All Urban Consumers, rounding to the nearest $1 million.

SEC. 1011. EXEMPTION FROM XBRL REQUIREMENTS FOR EMERGING GROWTH COMPANIES AND OTHER SMALLER COMPANIES.    Exempts EGCs from the requirement to use XBRL for financial statements and periodic reports, although EGCs may elect to use it. Also exempts companies with total annual gross revenues of less than $250 million until five years after the date of enactment or two years after a determination by the SEC, after conducting a detailed cost/benefit analysis as prescribed in the bill, that the benefits of the requirements to issuers outweigh the costs, but no earlier than three years after enactment.  Also requires the SEC, within 60 days, to revise its rules to reflect these exemptions and to report to Congress in a year.

SEC. 1026. EXPANDED ELIGIBILITY FOR USE OF FORM S–3.  Requires the SEC, within 45 days after the date of the enactment, to revise Form S–3 to permit securities to be registered under General Instruction I.B.1. (primary offerings by certain registrants) if the registrant has either at least $75 million in market value of common equity held by non-affiliates or a class of common listed on a national securities exchange.  Also, removes the requirement that the registrant have a class of common listed on a national securities exchange to be eligible to use General Instruction I.B.6 (limited primarily offering by certain other registrants).

SEC. 1041. TEMPORARY EXEMPTION FOR LOW-REVENUE ISSUERS. The JOBS Act exempted EGCs from the requirement in SOX 404(b) to have an auditor attestation and report on management’s assessment of internal control over financial reporting. (Note, however, that management’s annual report on internal control is still required.)  This provision would extend that exemption for an additional five years for any issuer that ceased to be an EGC on the last day of the fiscal year after the fifth anniversary of its IPO, had average annual gross revenues of less than $50 million as of its most recently completed fiscal year, and was not a large accelerated filer. The issuer would become ineligible for the exemption at the earliest of the last day of its fiscal year following the tenth anniversary of its IPO, the last day of its fiscal year when its average annual gross revenues exceeded $50 million, or the date on which it became a large accelerated filer. (See this PubCo post.)

SEC. 1066. REVISIONS TO REG D. Requires the SEC to reduce the need to file multiple Forms D under Rule 506.  Prevents the SEC from conditioning the availability of any exemption under Rule 506 on filing of a Form D.

SEC. 1082. REGISTRATION OF PROXY ADVISORY FIRMS. Provides for the registration of proxy advisory firms, which could include disclosure of information regarding the firms’ adequacy of internal resources, codes of ethics, conflicts of interest and related policies to address and manage conflicts.  Requires the SEC to issue rules to prohibit, or require the management and disclosure of, any conflicts of interest relating to the offering of proxy advisory services, such as those that may arise out of compensation by clients, the provision of consulting services or business relationships or personal interests with clients, transparency around the formulation of proxy voting policies, the execution of proxy votes and making vote recommendations where the issuer is not a proponent or where the proxy advisory firm provides advisory services.  The SEC is also required to issue rules prohibiting conduct such as conditioning or modifying a vote recommendation based on the purchase of services or products. Requires annual reporting by registered proxy advisory firms. Precludes a private right of action.  Directs the SEC staff to withdraw two no-action letters related to the circumstances under which a proxy voting firm could be an independent third party for purposes of making proxy voting recommendations for an investment adviser’s clients.

This post comes to us from Cooley LLP. It is based on the firm’s client update, “Undo Dodd-Frank?,” dated November 9, 2016, and available here.