Changes in Financial Regulation in the Time of Trump: Financial Choice Act

Prior to the political earthquake created by the US election, there was little interest in the broad-based legislation known as the Financial Choice Act, let alone hope that it would direct policy in the coming four years. The brainchild of Jeb Hensarling (R, TX), chair of the House Financial Services Committee, the legislation was largely seen as an ideological wish list for financial market regulation reform; a document indicating what the Committee along with its leadership and staff believe financial regulatory policy should do to address perceived regulatory excesses and anemic growth. But the election of Donald Trump as president, and continued Republican control of both the House of Representatives and Senate have given this legislation new significance.

The greater significance is related to several factors unique to the nature of the election campaign. For one, the enigmatic campaign of President-elect Trump offered sweeping principles about his governance ideas, including his disdain for the Dodd–Frank Act of 2010 and an off-the-cuff call for a revival of the Glass–Steagall Act. Beyond these, however, the campaign shed little light on concrete policy ideas, which makes the Choice Act the sole legislative option currently available to the new administration — there is nothing comparable in the Senate.

The Financial Choice Act also benefits from the personal connection between Hensarling and his former House colleague and current vice president–elect, Mike Pence. The pair served together for 11 years in the House, with Hensarling succeeding Pence as chair of the Republican Study Committee, a caucus of 172 Republican House members advocating for conservative causes. Pence’s presence as President of the Senate and adviser to President-elect Trump could boost the chances for all or part of the legislation to be signed into law.

Replacing Dodd–Frank and DOL Fiduciary Rule

The Choice Act is as wide-ranging as Dodd–Frank, its principal nemesis and inspiration. The Act’s 16 sections cover everything from bank regulation, fiduciary duty rules, and small company funding to the definition of accredited investors and abolition of Dodd–Frank’s rules on conflict minerals.

Most notable for CFA Institute members is the bill’s reassertion of the SEC as the agency with the authority to regulate and oversee advisers that provide investment advice. This assertion is a direct attack on the DOL’s fiduciary duty rule, adopted as a final rule earlier this year (2016). That rule is a regulation that President-elect Trump could, with little trouble, overturn.

Under the bill, the SEC would have the authority to address any deficiencies in investor protection for small and retirement investors, but only after a cost–benefit analysis. First, it would have to determine whether retail investors are being hurt by current standards of care by broker/dealers. Second, any proposed remedies would have to be shown to reduce investor confusion and harm. Third, the Commission would have to determine whether a single fiduciary duty would hurt the commissions of broker/dealers and/or reduce the availability of certain investment products for investors. And finally, it would have to determine whether a single fiduciary duty would reduce the availability of personalized investment advice for retail investors.

To reiterate our long-standing position, CFA Institute advocates for clarity in terminology used to describe the persons involved in providing investment advice. We argue that all in the United States who provide personalized investment advice to retail clients and describe themselves as advisers — including “financial advisors” — should be bound to the fiduciary duty obligations of the Investment Advisers Act of 1940. Anyone that wants to avoid the Advisers Act’s higher-level obligations would have to call themselves “salespersons.” The goal is to reduce investor confusion caused by the titles financial actors have used in the past that blur whether they have the best interests of their clients in mind when providing investment advice.

The Financial Choice Act focuses on a host of other Dodd–Frank provisions affecting the investment management business. Among other things, it would do the following:

• Change the definition of accredited investor to include individuals who have knowledge of, experience in, and understanding of financial markets and financial products.
• Enhance the SEC’s enforcement capabilities, including increasing its civil penalty authority and criminal sanctions under federal securities laws for the most serious offenses.
• Increase penalties for recidivist offenders of securities laws by permitting damages that are triple current monetary penalties.
• Give defendants in SEC enforcement cases the right to remove their cases to federal courts and to appear before the Commission prior to a formal enforcement action.
• Amend securities laws to permit the founding of a venture exchange for small-cap and JOBS Act companies.

Although the legislation has largely flown under the radar of capital market participants, it gained notoriety in June as a consequence of three proposed changes to regulation of big banks. The first would give banks the option to avoid the more active regulatory oversight of their lending, investing, and funding activities that they currently endure if they choose to maintain a minimum of 10% shareowners’ equity. The second proposal also would repeal the Volcker Rule, cited in the bill as not only a hindrance for bond market liquidity but, increasingly, as a heavy regulatory burden for small banks that have to justify their investment securities activities to regulatory examiners. Lastly, but by no means least, is the proposal to replace Dodd–Frank’s Title II Orderly Liquidation Authority with a bankruptcy-based structure that would impose meaningful losses on creditors of failed banks. This proposal, together with the so-called “living wills” for banks, was an attempt to ensure there was a plan to unwind a mega bank without taxpayer funded bailouts.

Senate at a Standstill

Prior to the election, Hensarling was hoping to bring the Financial Choice Act to a floor vote in the full House of Representatives during the lame-duck session, lasting between now and the end of the year (a new budget bill must be approved by 8 December to replace the current Continuing Resolution that expires that day). Its passage in the House was uncertain because it contains provisions that some Republicans would prefer not to register a vote on. But now, time is on Hensarling’s side to slice and dice his current plan, or develop an entirely new one, under which a successful vote could occur.

Even so, there is still the complication of the Senate. As noted earlier, it has no comparable legislation, and if the Choice Act were to reach the Senate, it is expected to have a difficult time. Sixty members must vote to end debate on any bill, which would require assistance from Senate Democrats and is highly unlikely in this case given their opposition over the past six years to even “correcting the misspellings and misplaced commas” in Dodd–Frank.

But as the only option currently available, Hensarling’s bill quickly moved from the backburner to primary indicator of financial market regulation, all in a matter of hours.

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