The Disqualification Provisions and the SEC’s Use of Wavers
One key debate regarding current SEC enforcement policy centers on the application of the so-called “bad actor” provisions. Previously the Commissioners split over the nature, use and application of those provisions. Central to the debate is whether the application of those provisions is an additional enforcement sanction or a remedial provision and how the decision on a waiver or its application is made.
Chair White’s views
SEC Chair Mary Jo White detailed her views on the application of these provisions in recent remarks at the Corporate Counsel Institute, Georgetown University, titled “Understanding Disqualifications, Exemptions and Waivers Under the Federal Securities Laws (March 12, 2015)(here).
Chair White began by drawing a distinction between enforcement remedies and disqualifications resulting from them. As to the former, the SEC has “broad authority to bring enforcement actions for violations of the securities laws . . . The Commission is authorized by statute to seek a variety of enforcement sanctions and other remedies . . .” which are tailored to the misconduct involved in the particular case, she noted.
A separate question involves “disqualifications from engaging in specific, regulated activities for individuals and entities that are the subject of certain kinds of enforcement actions or prosecutions. For example, if, on account of the unlawful actions of one or more employees, an entity is subject to certain enforcement actions and remedies or convicted of certain crimes, Section 9(a) of the Investment Company Act provides for the disqualification of the entire firm from serving as an investment adviser for a registered investment company. Rule 405 of the Securities Act provides that a well-known seasoned issuer (WKSI) can be disqualified from accessing the public capital markets on an accelerated and streamlined basis if it become an ‘ineligible issuer.” Rule 506 of Regulation D of the Securities Act, the new ‘bad actor’ provision under the Dodd-Frank Act, provides for disqualification from relying on the rule’s private placement exemption in connection with a securities offering.” There are other provisions similar provisions in the federal securities laws.
These provisions differ from the sanctions applied in enforcement actions. Each is designed to “safeguard investors and our capital markets from those whom we do not think should be able to fully function in them because of their past conduct,” Chair White noted. To illustrate this point she cited the legislative history of Investment Company Act Section 9(a) which provides in part that the drafters intended to “’get rid of persons with criminal records, persons who were under injunctions from courts of competent jurisdiction for improper practices in connection with securities . . . Our purpose was simply to try to get that type of person out of this business – where such persons ought to be out of it.’”
These provisions are triggered automatically. Each is broad to cover a range of situations. “To temper the potential over-breath of the disqualification provisions, the securities laws also provide explicit grants of authority and discretion to the Commission . . .” to provide for waivers under specific circumstances.
The Commission and its staff have established a rigorous process for considering the application of these provisions, Chair White stated. The staff considers a number of factors which include the nature of the violation, the duration of the wrongdoing, the specific employees involved and their level of seniority and responsibility and their state of mind. In addition, the staff “considers whether the conduct touched at all upon the activity at issue in the disqualification . . . the extent of the remediation implemented by the institution in the wake of the enforcement action . . . and if that is bona fide and effective . . . A repeated string of serious violations, on the other hand, can call into question whether a firm’s compliance culture and ‘tone at the top’ are so deficient that there is cause for concern even in unrelated areas of the firm” Chair White stated.
Finally, to improve the transparency of the process the staff last year reviewed its guidance on WKSI waivers and is developing similar guidance for others. This guidance is “intended to provide a clear explanation of factors the staff considers in evaluating waiver requests.” Accordingly, the process is “through, rigorous, and principled . . .” Chair White concluded.
Controversy has swirled around the application of the disqualification provisions. Chair White’s discussion focused on one key issue – are they enforcement remedies or remedial provisions designed to protect the markets and investors.
In her view those provisions are not enforcement remedies. Others disagree. For example, in recent remarks Commissioner Gallagher made it clear that the provisions are being used to enhance enforcement penalties (here).
Regardless of the intent behind the provisions, one point is clear. The disqualifications flow from the resolution of an enforcement action by the SEC or in some instances other enforcement officials. Arguing about whether they are additional sanctions or “remedial” is in large measure a pointless debate which depends on whose view is adopted. The SEC may view them as remedial since they protect the market from a “bad actor” in the future just as a prison term protects the public from the bad person incarcerated. From the point of view of the person on whom they are imposed however, they are additional punishment – no doubt the person in prison does not see the sentence as “remedial” but as punishment.
What Chair White did not address is the approach to waivers. While the staff may have a rigorous and fair process, as Commissioner Gallagher noted the imposition of those provisions comes after the enforcement action is settled. That means a person resolving an enforcement action has no way to determine at the time of settlement if additional, non-negotiated provisions will be added to the sanctions imposed regardless of whether they are labeled “remedial” or “punitive.” This presents a basic question of fairness regardless of what label is applied to the disqualification provisions or the transparency of the process used by the staff.