There’s been a lot of talk since the election about dismantling the Dodd-Frank financial reform act. On his website, President-elect Donald Trump blames Dodd-Frank’s “bureaucratic red tape and Washington mandates” for strangling economic growth. The chairman of Trump’s panel of business advisers, Blackstone CEO Steve Schwartzman, said at a Goldman Sachs conference Tuesday that the president elect expects to effect the biggest financial regulatory roll-back in decades.
I’ve been wondering how the Trump administration’s Securities and Exchange Commission will approach enforcement of the securities laws. As you probably recall, the SEC was scapegoated in the years after the 2008 financial crisis for failing to investigate and punish banks that promoted risky mortgage-backed securities and, in some cases, profited from the collapse of the housing market. But as the pendulum swung toward more stringent enforcement, defendants criticized the SEC and the Justice Department for extracting billion-dollar penalties that were, at least as defendants saw it, unmoored from actual violations.
Enforcement defendants and their lawyers have also spent the past few years complaining bitterly about the SEC’s increased use of administrative proceedings – which take place before in-house judges, under rules set by the agency – instead of federal court enforcement actions. When the president-elect’s appointees take control of the agency, will they continue to capitalize on the procedural advantage Congress authorized in Dodd-Frank?
At a seminar I attended last week, white collar defense partner David Meister of Skadden Arps Slate Meagher & Flom suggested a starting point for thinking about SEC enforcement in the Trump era: the House Financial Services Committee’s Financial Choice Act, which passed a committee vote in September but never made it to the House of Representatives. Meister cautioned, of course, that we don’t know which, if any, of the bill’s proposals will make it into law. Nor has the president-elect named his nominee to head the SEC. At the moment, in other words, we can’t be sure how the agency’s enforcement strategy and tools will change.
That said, Representative Jeb Hensarling has made it clear that he plans to reintroduce the Financial Choice Act in the next Congress. He has also met with President-elect Trump, before and after the election, to discuss his ideas for retooling Dodd-Frank, which include changes to the structure of the Consumer Financial Protection Bureau and repeal of the Volcker Rule on proprietary trading, among many other things. The president-elect’s website echoes the Financial Choice Act’s language on Dodd-Frank and financial reform, which suggests the future Trump administration takes the proposed law seriously.
So what does the Choice Act have to say about SEC enforcement? The law talks about holding Wall Street and Washington accountable if there’s another financial crisis and proposes a higher ceiling on penalties the SEC is permitted to impose for the most serious violations of securities laws. But at the same time, the bill would severely restrict the SEC’s ability to punish public companies. In order to impose penalties, the proposal would require the agency to prove that the alleged violation directly benefited the accused issuer – and that shareholders in the company won’t be harmed as a result of the penalty. “The SEC must strike the right balance between deterring and punishing securities fraud and protecting shareholders ultimately responsible for paying large civil penalties for violations they did not commit,” the law’s summary explained.
The Choice Act would also weaken the SEC’s negotiating leverage by restricting the commission’s ability to threaten automatic disqualification from regulated activities. According to former SEC Commissioner Dan Gallagher, a Republican appointee, the agency historically used automatic disqualification of individuals and institutions to prevent repeat securities violations. Large institutions typically received waivers from automatic disqualification, Gallagher said in a speech in February 2015, but in recent years, the automatic disqualification system – and supposedly punitive use of the waiver process - has become a way to enhance sanctions, Gallagher wrote. He argued that disqualification should not be conflated with sanctions, and the House Financial Services proposal agreed. The Choice Act would eliminate automatic disqualifications and give the SEC discretion to tailor disqualifications to punish “the worst offenders.”
Administrative proceedings will be significantly curtailed if the Choice Act goes through. The law would allow SEC defendants to remove their cases to federal court, even if the SEC files the case as an administrative proceeding. It would also allow defendants to present arguments to the commission before the SEC institutes an administrative proceeding and would put in place an ombudsman to review complaints about the entire enforcement program.
I presume a cooperative SEC chair could institute many of the Choice Act’s proposals even without the law passing. It’s up to the commission, for instance, to pick a jurisdiction for enforcement actions, so a new chair and enforcement director could simply send cases to federal court rather than to administrative law judges. The agency could also revise its internal guidelines on assessing penalties and imposing disqualification, regardless of the fate of Representative Hensarling’s proposed law.
Defanging the agency charged with assuring market integrity is a risky move, especially for a president elected as a populist. SEC enforcement is one of those areas where the interests of small-time investors and large corporations don’t necessarily coincide. We haven’t had a financial crisis since Dodd-Frank was enacted. Let’s hope that streak continues.
I left a message for Sharon Brown-Hruska of NERA Economic Consulting, who has been appointed to President-elect Trump’s landing team at the SEC (and two other regulatory agencies). She did not respond.