RIA Compliance Blog
SEC Chairman Jay Clayton recently announced, on behalf of the Commission, a significant change in policy as to how the SEC will consider requests for disqualification waivers made by respondents in SEC enforcement proceedings where a settlement offer is being negotiated. We think that Clayton is to be applauded for this move as the new policy should prove to be a fairer and more efficient alternative to the status quo that has prevailed in recent years, most notably because it will give respondents a heightened degree of certainty regarding “collateral consequences” of an enforcement settlement.
First a bit of background. While the majority of SEC enforcement proceedings are resolved with a settlement agreement between the SEC and the respondent resulting in fines, restitution to investors, or other sanctions, a secondary or “collateral” consequence of the settlement may be statutory disqualification under the securities laws of the respondent (or an affiliate) from some otherwise permissible activity. A prime example is the so-called “bad-boy” provisions of Reg D, which, among other things, prohibit persons subject to SEC cease-and-desist orders or other SEC disciplinary orders from raising capital in a Reg D private placement. Another example is the prohibition on receipt of cash fees for solicitation under Rule 206(4)-3 of the federal Advisers Act where the solicitor is subject to certain SEC disciplinary orders. As noted by Clayton, “[t]he effects of these collateral consequences can vary widely depending on the scope of the businesses and operations of the entity and, in practice, range from immaterial to extremely significant.”
In cases where the collateral consequences of a settlement are in fact significant, respondents typically seek waivers from the Commission, which has the authority to grant such waivers either in full or subject to conditions. Respondents negotiating settlements with the SEC often make contemporaneous settlement offers and waiver requests. However, and to the consternation of respondents, these waiver requests have historically been handled separately—both in time and by potentially different decision-makers. Specifically, while a settlement offer will generally be negotiated with the SEC’s Enforcement Division, waiver requests go to other divisions within the SEC, such as Corporation Finance or Investment Management. These other divisions obviously all have autonomous management, and have their own timetables, policies and procedures vis-à-vis entertaining waiver requests. While the ultimate decision to accept a settlement offer or a waiver request was oftentimes made by vote of the SEC Commissioners, in some cases it was made by division staff pursuant to delegated authority. Accordingly, in a worst-case scenario, a respondent might find itself boxed-in to an untenable situation resulting from an accepted settlement offer and a rejected waiver request.
Recognizing that the current process “undermines factors that drive appropriate settlements” and “may not lead to the best outcome for investors and can unnecessarily tap Commission resources,” Clayton’s pronouncement revises the process entirely. Clayton strongly articulates the rationale for his pronouncement, stating “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.” According to Clayton, “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.” Moreover, Clayton’s pronouncement effectively allows respondents to make their settlement offers contingent on receiving any waivers deemed necessary by the respondent. Previously, contingent settlement offers had been prohibited. Accordingly, now respondents will have a five-day grace period to reconsider their settlement offer if requested waivers are ultimately denied. Finally, while it is clear that the Commission, in considering settlement offers and waiver requests, will continue to heavily rely on the recommendations of the SEC’s divisional staff, it does appear that the new process going forward will not allow for the divisions to unilaterally approve waivers or settlements pursuant to delegated authority.
Again, we concur with the Chairman’s rationale for his pronouncement, and believe that the result will be a fairer and more efficient settlement process, primarily due to the increased certainty that it brings. As Clayton points out, “a [major] factor that drives appropriate settlements is a desire for certainty.” In particular, he notes that “the ongoing and potential consequences of a litigated action often motivate an entity to pursue a settlement that puts the matter behind it.” However, as noted above, the effect of “collateral consequences” can be that the matter cannot be put in the rearview mirror, and remains an impediment to moving forward. As Clayton states, “the Commission’s willingness to zealously pursue all appropriate remedies often is a strong stick and, at the same time, the ability of the Commission to provide a full and final resolution of a matter often is a significant carrot.” We agree that for that carrot to be an enticing one, the matter’s resolution must truly be a” full and final one”, free of collateral consequences down the road.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including complying with federal and state laws and rules. Please visit our website for more information.