On April 19, Rep. Jeb Hensarling (R-TX) published a discussion draft of his Financial CHOICE Act (Version 2), updated from his original 2016 draft (Version 1). While keeping what the Rep. Hensarling calls its “pro-growth, pro-consumer” features that would end “too-big-to-fail” bailouts, the 2017 discussion draft of the Financial CHOICE Act walks back or modifies some key provisions from the 2016 version. Version 2 retains the "Dodd-Frank offramp,” the optional exemption from many Dodd-Frank regulations in exchange for higher capital reserves, that was the centerpiece of Version 1. This new version, however, provides more incentives to banks to take the offramp, in the form of exemptions from stress testing. As with Version 1, Version 2 also repeals the Volcker Rule and eliminates enhanced supervision of financial market utilities designated as systemically important by the Financial Stability Oversight Council. The bill also adds new provisions drastically limiting the powers of the CFPB, and modifies various regulatory abilities of the SEC, PCAOB, and the CFTC.
Version 2 leaves in place the offramp for “Qualifying Banking Organizations” (QBOs) that maintain a leverage ratio of at least 10% of Tier 1 capital, but eliminates Version 1’s requirement that the QBO have a CAMELS score of 1 or 2 at the time the bank makes its election. Version 2 also adds another incentive to opting in to the QBO framework. In version 2, QBOs are not only exempt from all other Dodd-Frank regulatory ratios, but freed from the Fed's stress testing requirements as well.
Operational Risk Capital
Regardless of whether a bank opts into the CHOICE Act’s off-ramp, Version 2 provides another avenue for capital relief. Notably, Version 2 also provides that capital reserve requirements for banks must permit “adjustments based on qualified operational risk mitigants.” While Version 2 does not define what constitutes “qualified operational risk mitigants,” presumably banks who demonstrate superior operational risk management and who have invested heavily in measures to control operational risks would be eligible for some form of bank capital relief.
The consideration of “qualified operational risk mitigants” is part of a larger change proposed in Version 2 to the way bank regulators set capital standards. When setting capital requirements, the new bill opts for a reliance only on forward-looking assessments of a bank's present activities without regard to a bank’s historical losses, but, as noted above, taking into consideration the quality of bank risk management. Under Version 2, banking agencies "may not establish an operational risk capital requirement for banking organizations, unless such requirement -
(1) is based on the risks posed by a banking organization’s current activities and businesses;
(2) is appropriately sensitive to the risks posed by such current activities and businesses;
(3) is determined under a forward looking assessment of potential losses that may arise out of a banking organization’s current activities and businesses, which is not solely based on a banking organization’s historical losses; and
(4) permits adjustments based on qualifying operational risk mitigants."
Other Notable Changes from Version 1
Stress Tests. In addition to exempting QBOs from stress testing, Version 2 also changes the Fed’s stress testing regime for banks not taking the off-ramp, providing for:
- the confidentiality of stress testing results and bank living wills, establishing criminal penalties for unauthorized disclosure of living will and stress test determinations by federal officials; and
- implementation of certain improvements suggested by the GAO, including requiring a better understanding of the trade-offs between financial stability and cost/availability of credit and potential for model risks and pro-cyclicality.
Supplemental Leverage Ratio. Version 2 adjusts the timing of the finalization of SLR calculations to correspond to the passage of Version 2 rather than the SLR’s current effective date.
Fiduciary Liability Standard. Version 2 adds a provision that parties suing investment companies by a private right of action for fiduciary breaches under Section 36(b) of the Investment Company Act of 1940 must plead their cases more specifically and meet a higher burden of proof to win. The new pleading language would require that “the complaint shall state with particularity all facts establishing a breach of fiduciary duty, and, if an allegation of any such facts is based on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” The new provision raises the burden of proof for plaintiffs from a "preponderance of the evidence" to "clear and convincing evidence."
At the moment, the Version 2 remains a discussion draft and has not been introduced formally as legislation. Hearings on Version 2 of the CHOICE Act are scheduled to begin on April 26, 2017 before the House Financial Services Committee. The witnesses scheduled for this initial hearing are:
- Mr. John Allison, Former President and Chief Executive Officer, Cato Institute
- Dr. Norbert J. Michel, Senior Research Fellow, Financial Regulations and Monetary Policy Institute for Economic Freedom and Opportunity, The Heritage Foundation
- Ms. Hester Peirce, Director of Financial Markets Working Group and Senior Research Fellow, Mercatus Center
- Mr. Alex J. Pollock, Distinguished Senior Fellow, The R Street Institute
- Mr. Peter J. Wallison, Senior Fellow and Arthur F. Burn, Fellow in Financial Policy Studies, American Enterprise Institute
The full text of the Version 2 discussion draft is available via: https://financialservices.house.gov/uploadedfiles/choice_2.0_discussion_draft.pdf
A chart comparing Version 2 to Version 1 is available via: https://www.thecorporatecounsel.net/nonmember/docs/04_11_17_changes.pdf
 The Financial CHOICE Act (H.R. 5983) was introduced in July, 2016, by Representative Jeb Hensarling (R-TX), Chairman of the House Financial Services Committee, and reported out in September, 2016. However, the bill failed to make the legislative calendar prior to the start of the election season recess.
"Any officer or employee of a Federal department or agency, who by virtue of such officer or employee’s employment or official position, has possession of, or access to, agency records which contain individually identifiable information submitted pursuant to the requirements of this sec- tion, the disclosure of which is prohibited by Federal statute, rule, or regulation, and who knowing that disclosure of the specific material is so prohibited, willfully discloses the material in any manner to any person or agency not entitled to receive it, shall be guilty of a misdemeanor and fined not more than $5,000."
"Additional Actions Could Help Ensure the Achievement of Stress Test Goals." GAO-17-48: Published: Nov 15, 2016. Publicly Released: Nov 15, 2016. https://www.gao.gov/products/GAO-17-48. The GAO publication recommended:
- increasing the transparency of the assessment approach or reasons for objections to a bank’s capital plan;
- addressing model risk -- the risk that the Fed may make adverse decisions based on incorrect or misinterpreted model outputs; and
- better stress testing scenario design.