Changing of the HFSC Guard (April 2)

Update 343 — Changing of the HFSC Guard:
New Members and Majority on Capital Markets

Tomorrow, the House Financial Services Subcommittee that considers bills regulating capital markets activities will do so for the first time this Congress.  Gone are the days when the Subcommittee’s majority pursued a deregulatory campaign to undo Dodd-Frank protections against abuses like fraud and self-dealing.

Instead, the hearing will be lead by Subcommittee chair Carolyn Maloney of New York and will feature appearances by several high-profile members of the freshman class, including Katie Porter of California and Alexandria Ocasio-Cortez of New York — must-watch by Subcommittee standards.  

More on the hearing below.  




Tomorrow, the House Financial Services Committee (HFSC) Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets will convene for its first hearing this Congress on six investor protection bills. While many of the bills are modest in scale, they mark an important shift in the House away from the anti-investor deregulatory agenda of former HFSC Chair Jeb Hensarling, toward one that polices capital market abuses like fraud or self-dealing more vigilantly.

The bills seek to bolster insider trading laws, prohibit the use of mandatory arbitration clauses in investor and shareholder agreements, implement Dodd-Frank Act (DFA) rules on executive pay and compensation disclosures, and ensure whistleblowers have adequate protections from retaliation.

  • Insider Trading Prohibition Act

This bill seeks to create a statutory definition of insider trading for the sake of clarity and to make it easier to prosecute. Currently, insider trading is treated as common law fraud, and the U.S. government litigates cases under the Securities and Exchange Act of 1934. In Rep. Himes’ bill, insider trading is defined as “trading based on material, nonpublic information that was wrongfully obtained,” something that up until now has been adjudicated through case law.   

Himes’ bill would define insider trading, clarifying rules for investors and giving prosecutors clearer guidance to punish wrongdoing. A version of this bill was introduced by Himes in the 114th Congress, with 31 cosponsors, including two Republicans.

  • Investor Choice Act of 2019

Rep. Foster’s discussion draft would prohibit both broker-dealers and investment advisers from including mandatory arbitration clauses in their agreements with customers. It would also prohibit public companies from including mandatory arbitration clauses in their bylaws or other corporate governance documents.

The DFA gave the SEC authority to prohibit or condition the use of mandatory arbitration clauses in broker-customer agreements, as well as in agreements between investors and investment advisers, but the SEC has never used this authority. Mandatory arbitration prevents investors from taking broker dealers to court; ending this practice would be a significant investor protection measure. Former Democratic Rep. Keith Ellison introduced H.R. 585, a similar bill by the same name, in 2017 and in 2013.

  • 8-K Trading Gap Act of 2019

Introduced by Rep. Carolyn Maloney, the 8-K Trading Gap Act of 2019 would direct the SEC to issue a rule requiring public companies to prohibit officers and directors from trading company stock following an undisclosed significant corporate event. SEC rules currently require companies to file a Form 8-K within four business days after the corporate event occurs, so company executives may know about material, nonpublic information (and are able to trade on that information) up to four days before disclosure to investors and the public.

A 2015 study found that over a six-year period, insiders who traded during this four-day gap successfully earned $105 million in above-market returns on these trades. Senator Van Hollen and SEC Commissioner Robert Jackson have both brought this issue to the fore. This bill could conceivably pass in the Senate as part of a broader package.

  • Bill to Require Section 10D Rulemaking by the SEC

This bill directs the SEC to finalize a DFA-mandated rule originally proposed by the agency in 2015 — it is one of five mandatory compensation rules that the SEC has failed to approve since the financial crisis and passage of DFA. The rule makes financial executives liable for erroneously awarded incentive-based compensation, otherwise known as a “clawback” rule.

The rule expands on the existing 2002 Sarbanes-Oxley clawback rule, extending it to all executives, not just the CEO and CFO. It removes the misconduct requirement before being able to clawback compensation. The existing Sarbanes-Oxley clawback rule has been used to recover hundreds of millions from ex-executives accused of malfeasance. (On Monday, Hertz Global Holdings announced it was seeking $70 million in clawbacks from its ex-CEO and other senior manager over an accounting scandal in 2014.)

  • Bill to Require section 14(i) Rulemaking by the SEC

Section 953(a) of DFA directed the SEC to issue a rule requiring public companies to disclose a clear description of any executive compensation, including information on “the relationship between executive compensation actually paid and the financial performance of the company.” This bill aims to hold corporate executives accountable by linking executive compensation and the company’s financial performance, and making that link (or lack thereof) clear to shareholders.

The SEC has never issued the rule required by section 953(a) of DFA. This discussion draft would require the SEC to finalize the rulemaking within 60 days and if it doesn’t, the SEC Chair is required to testify in front of the House Financial Services Committee and the Senate Banking Committee once a month until the rule is complete.

  • Bill to Amend SEC Whistleblower  Definition

Texas Rep. Al Green sponsored this discussion draft that aims to better protect whistleblowers from employer retaliation. In the 2018 Supreme Court case Digital Realty Trust v. Somers, the court found that whistleblowers who report alleged misconduct internally, but not to the SEC, are not protected by the anti-retaliation provisions of Dodd-Frank. This amendment would expand Dodd-Frank protections to include those internal whistleblowers as well.

Waters’ Investor Protection Agenda

Most of the aforementioned bills, besides the 8-K Trading Gap Act, are unlikely to get much attention in the Senate, but they illustrate the importance of investor protection to Chair Waters.  Expect more of the same from the HFSC this Congress, with other investor protection measures, such as ending multi-class share structures, broker misconduct, and resolving unpaid judgments for investors all in the Committee’s crosshairs in the coming months.

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