The new Administration in Washington brings an expectation of change at the SEC in many areas, one of them being SEC Enforcement, where a shift toward more aggressive enforcement is anticipated. That change has already begun. A week ago, Acting SEC Chair Allison Lee restored authority to senior officers in Enforcement to approve the issuance of Formal Orders of Investigation, an action designed to allow senior officers, under delegated authority, to authorize staff to subpoena documents and take sworn testimony. This delegated authority could have the effect of accelerating action by the SEC. And just a couple of days later, Lee, in consultation with Corp Fin, Enforcement and Investment Management, took action to ensure that Enforcement will no longer recommend to the SEC “contingent settlement offers,” that is, settlement offers that are conditioned on the grant of waivers of the automatic disqualification that results from certain securities violations or sanctions. The action was intended “to reinforce the critical separation” between the enforcement process and the consideration of requests for waivers to ensure that the process for “consideration of waivers is forward looking and focused on protecting investors, the market, and market participants from those who fail to comply with the law.” Will the change have any impact?
Companies that are determined to have violated certain federal securities laws are automatically disqualified from, among other things, being considered a WKSI (well-known seasoned issuer) under Rule 405 and enjoying all the advantages associated with that status, and engaging in certain private securities offerings under Rule 506 of Reg D. Lee notes that companies may also be disqualified from
“the use of the statutory safe harbor for forward looking statements. These privileges allow companies to raise money from investors more quickly, and often with less expense, than would be possible without the flexibility these privileges afford, while also potentially providing less information to investors. While they are available to companies that use them responsibly, they can expose investors and markets to risk when used by those who cannot or will not follow the rules. In addition, individuals or entities that have been subject to certain sanctions, such as a criminal conviction pertaining to investment related activities or injunctive relief barring them from certain roles in the securities industry, are automatically disqualified from serving in certain capacities at registered investment companies under Section (9)(a) of the Investment Company Act.”
However, the SEC has the discretion to waive these disqualifications, and the regularity with which the SEC has granted these waivers has long come under fire. For example, then-SEC Commissioner Kara Stein repeatedly dissented to the grant of waivers, arguing that they allowed companies that sometimes engaged in recidivist behavior to rely on recurrent waivers from the SEC to continue business as usual, even after a number of serious violations.
In 2019, then-SEC Chair Jay Clayton announced a new policy that permitted settlement offers to be contingent on granting these waivers on the theory that the policy could “facilitate and expedite settlement negotiations and settlement agreements,” speeding relief to injured parties. Historically, said Clayton, settlement agreements and waivers had been considered by the SEC “almost exclusively on a segregated basis.” However, according to Clayton:
“Considering a settlement offer and a related waiver request as if they are two separate and unconnected events can add complexity, including because such a formulaic separation often is inconsistent with appropriate consideration of the substance and interconnected nature of the matters at issue and undermines factors that drive appropriate settlements. The complexity added by such a separation can substantially complicate and lengthen the negotiating process, which, among other consequences, may not lead to the best outcome for investors and can unnecessarily tap Commission resources…. Recognizing that a segregated process for considering contemporaneous settlement offers and waiver requests may not produce the best outcome for investors in all circumstances, I believe it is appropriate to make it clear that a settling entity can request that the Commission consider an offer of settlement that simultaneously addresses both the underlying enforcement action and any related collateral disqualifications. To be more specific and to discuss the issue in context, an offer of settlement that includes a simultaneous waiver request negotiated with all relevant divisions (e.g., Enforcement, Corporation Finance, Investment Management) will be presented to, and considered by, the Commission as a single recommendation from the staff. This approach will honor substance over form and enable the Commission to consider the proposed settlement and waiver request contemporaneously, along with the relevant facts and conduct, and the analysis and advice of the relevant Commission divisions to assess whether the proposed resolution of the matter in its entirety best serves investors and the Commission’s mission more generally.”
As Lee observed, her action reflected a return to the prior long-standing position, ensuring “that the consideration of waivers is forward looking and focused on protecting investors, the market, and market participants from those who fail to comply with the law.” Although the SEC has discretion to grant waivers of disqualification, Lee maintained, those waivers “should not be used as a bargaining chip in settlement negotiations or regarded as an obstacle to be overcome on the way to a settlement. A waiver is not the default position under the law, and should not be considered one under our processes.” What’s more, she observed, the standards for review of requests for waivers used by Corp Fin (and Investment Management) are different from the standards that Enforcement uses to bring and settle cases. While a waiver “may be appropriate, this determination should be made separately, as a policy matter, from considerations related to the settlement of an enforcement case.” With her action to reinforce this “critical separation,” Lee intended “to enshrine best practices and ensure that our policies and procedures are designed to eliminate the potential for any structural conflicts or pressures.”
In this subsequent Statement, SEC Commissioners Hester Peirce and Elad Roisman made clear their objections to this “abrupt change” in policy. In their view, the policy of considering and accepting contingent settlement offers did not change the standards applicable when Enforcement assessed the offer to settle or when Corp Fin considered the waiver, nor did it compromise their independence or create structural conflicts or pressures. “In short,” they said, “the policy worked well.” They also contended the policy recognized “the reality that an entity’s willingness to reach a prompt settlement on just and fair terms often is influenced by its concerns regarding the potential collateral consequences of entering into the settlement. The decision to disallow contingent settlement offers denies this reality—but it cannot change it. Insisting that an entity that is willing to settle be left in the dark about whether its waiver application will be granted significantly alters the entity’s settlement calculus because it undercuts the certainty and finality that settlement might otherwise provide.” In their view, Lee’s policy change “marks a return to an unwieldy process that treats as completely separate what is in fact interrelated. It re-introduces an artificial separation between the process by which an entity reaches a resolution on its violations of securities laws and the process by which it obtains clarity with respect to the collateral consequences of those violations. The result will be a longer period between the initiation and resolution of enforcement matters. We do not see how this outcome advances either the Commission’s mission or serves the interests of investors.”