The Potential Declawing of the SEC: The Financial CHOICE Act

Gavel and Hundred-Dollar Bill

The Financial CHOICE Act (or “CHOICE Act 2.0”), which would significantly narrow the SEC’s ability to bring enforcement actions and make it more challenging for it to prevail in such actions, is inching its way towards becoming law. On May 4, 2017, the Financial Services Committee passed the Act and it is now slated to be introduced to the House in the coming weeks. As part of the push by the current administration to deregulate, this bill aims to repeal key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, including those directed towards the SEC.  Although the Act has a long way to go before it is enacted, many of its provisions would have far-reaching consequences and would change the way the SEC operates as we know it.

Should the CHOICE Act 2.0 become law, the following are some of the more important effects it would have on the SEC’s enforcement abilities:

– Fewer Administrative Proceedings, and Proceedings that are Less Favorable to the SEC. The Act would give respondents in SEC enforcement actions the right to transfer their cases from administrative tribunals to federal district courts. Respondents could avoid having their cases heard by in-house administrative law judges, and instead proceed in what is often viewed as a less biased federal tribunal that maintains greater procedural and evidentiary safeguards. Moreover, if the action were to move forward in an administrative proceeding, the Act would change the standard of proof for the SEC from preponderance of the evidence to clear and convincing evidence. The likely result of these changes, should they take effect, would be to decrease in the number of administrative proceedings brought by the SEC, an outcome that many view as favorable for defendants.

– Limitations on the SEC’s Ability to Try Novel Theories or Create Rulemaking by Enforcement. Under the Choice Act 2.0, the SEC would be required to provide adequate notice, in the form of an approved statement or guidance, detailing what is considered unlawful conduct before it may bring an enforcement action based on such conduct. This change strips the SEC of flexibility to create new theories of liability within an existing rubric, or to effectively create new law. Though it is too early to tell how this change would be applied or enforced, it is reasonable to believe that unless the SEC has issued clear guidance, defendants would escape liability.

– No Judicial Deference to the SEC’s Interpretations of Laws it Administers. The CHOICE Act 2.0 would statutorily repeal the so-called Chevron doctrine, which currently bestows deference to the SEC’s interpretations of its laws in legal proceedings. Again, this change would make it more difficult for the SEC to prevail in an enforcement action.

– Required Coordination with Other Agencies. The Act also requires agencies, including the SEC, to coordinate with Federal and State authorities when bringing administrative or judicial actions. The SEC would be required to: (1) minimize duplication of efforts with other authorities; (2) establish when joint investigations are necessary, appropriate, and in the public interest; and (3) establish a lead agency in joint investigations. Take, for example, a situation where both the SEC and DOJ were considering investigating the same individual or entity. Although the SEC would presumably be allowed to continue a joint investigation if it is determined to be in the public interest, it may be forced yield control to the DOJ as the lead investigator, and would give reprieve to investigatees who would no longer be stretched to simultaneously respond to two full-blown investigations.

– Limit on Whistleblower Awards. Under the Act, co-conspirators would be barred from receiving whistleblower awards if they were “responsible for, or complicit in, the violation of the securities laws for which the whistleblower provided information to the Commission.” There have been numerous whistleblower actions in recent years, including by whistleblowers who were engaged in the misconduct at issue. In the past, those whistleblowers were not only given an award, but often an exculpatory pass as well. Moving forward, such whistleblowers would no longer receive an award and could find themselves facing liability for the misconduct, therefore likely reducing the number of claims raised.

-No More D&O Bars. The CHOICE Act 2.0 would repeal the SEC’s authority to bar individuals from serving as directors or officers in administrative proceedings.

Each of these provisions either reduces the authority that the SEC currently enjoys, or makes it more difficult for the SEC to prevail in the actions it does bring, or both. Should the CHOICE Act 2.0 be passed, it would likely reduce SEC enforcement activity and give more predictable results, both of which would be favorably received by companies and their directors and officers alike.  In particular, financial institutions and investment companies, which are heavily regulated by federal securities laws, would reap the benefits of the proposed changes.  While there remain several potential congressional obstacles to the Act, and we do not know what its final form will be if it becomes law, given its significant potential impact it certainly is deserving of discussion.