White: Disqualifications and Waivers Should Not Be Used for Enforcement
It would be wrong to do, and the SEC and its staff are not doing it.
That would seem to be the takeaway from SEC chair Mary Jo White’s March 12 speech at Georgetown University in Washington, DC, where she forthrightly stated that "waivers were never intended to be, and we should never use them as, an additional enforcement tool designed to address misconduct or as an unjustified mechanism for deterring misconduct."
"Nor would it benefit our enforcement program to impose disqualifications when the applicable legal standards do not support them," she said. "Deterring entities from settling charges they would otherwise settle by the unjustified denial of waivers could thereby delay relief to investors and lead us to expend resources on litigation that should be spent elsewhere."
In the same speech, however, she said that the Commission and its staff are following the correct standards and answering the correct questions regarding waivers or exemptions from disqualifications "in a very careful, principled manner, applying the applicable rules rigorously and fairly."
In voicing her opinions on the issue, White is answering a challenge made by two Commissioners,
Daniel Gallagher and Michael Piwowar, both of whom recently gave speeches in which they criticized the role played by waivers from disqualification in settlement negotiations (ACA Insight, 3/2/15).
Gallagher, in a February 13 speech
in Dallas criticized what he described as an "informal, non-Commission-approved practice recently followed by the Enforcement Division of not allowing respondents to condition settlements on the granting of waivers. This makes no sense to me. If a disqualification is now a sanction, then the waivers must be part of the settlement negotiations."
"This is especially true for financial services firms, which can effectively be sentenced to a corporate death penalty if certain waivers … are not granted. If the Commission wants to put firms out of business, something that always should be on the table in extreme enforcement cases, we should be doing so with our authority over the registration provisions of the securities laws, not [emphasis Gallagher] through automatic disqualifications," he said.
"A settlement should involve a meeting of the minds on all aspects of the resolution," Gallagher said. "A settlement should bring finality."
Piwowar, in a February 20 speech
in Washington, DC, called for guidelines to address the problem. "Having established guidelines is particularly important in the context of settlement negotiations to allow a party that is considering a settlement offer to determine whether, if it settles, it will be able to obtain the necessary waivers to continue to engage in certain business activities," he said, noting that, for many waiver requests, there already exist staff guidelines, which commissioners have "recently and with increasing frequency" been ignoring.
"I just cannot agree with White’s contention that there’s a distinction between an enforcement remedy and a disqualification resulting from them," said
Rogers & Hardin partner Stephen Councill. "While it is correct that the intent of a disqualification was to prevent future harm, the actual effect can be punitive. Disqualifying a person or an institution from participating in private
offerings can clearly have a draconian and punitive effect on certain people or institutions. A fund manager, for example, who cannot use a 506 offering to raise money for a private fund can be forced out of business."
"There is no reason why such drastic consequences resulting from a settled enforcement action should not be vetted on the front end when considering the merits of the case, as opposed to on the back end during a waiver process," he said. "If the conduct is such that the public interest requires the disqualification, then there is zero reason why that should not be considered when the enforcement case is being resolved."
"White is clearly pushing back on Gallagher, but it’s hard to see what the practical effect will be," said Stern Tannenbaum partner Aegis Frumento. "Gallagher argues that, as a practical matter, the availability of a waiver has to be weighed by persons charged by the SEC in deciding whether or not to settle those charges. According to Gallagher, it ignores reality to treat a waiver decision separate and apart from the settlement itself, and so he favors that settlements and waivers be negotiated together, presented to the Commission together, and be decided together.
"White is not necessarily saying don’t bring them up together, but she is clearly telling everyone that the legal basis for granting a waiver is different than the basis for bringing and settling an enforcement action," he said. "But so what? The two positions can easily be reconciled. The staff can certainly determine whether or not to support a waiver on the basis of the standards governing waivers, and at the same time determine whether to support a settlement on the basis of the standards governing settlements."
Much of the White’s speech appeared to be educational, explaining how enforcement penalties and disqualifications have different purposes and are applied in different ways.
"The federal securities laws distinguish between the remedies available for enforcement violations, on the one hand, and disqualifications, on the other," she said, noting that the Commission has "broad authority to bring enforcement actions for violations of the securities laws … against individuals, public companies, financial institutions, investment advisers, broker-dealers and others." The sanctions the SEC can bring include injunctions and cease and desist orders, temporary or permanent bars from participating in aspects of the securities industry, disgorgement, financial penalties, and various undertakings, such as hiring a compliance consultant.
Disqualifications, on the other hand, prevent individuals and entities that are the subject of certain kinds of enforcement actions or prosecutions "from engaging in specific, regulated activities." For instance, she said, Rule 506 of Regulation D of the Securities Act, the Bad Actor Rule, "provides for disqualification from relying on the Rule’s private placement exemption in connection with a securities offering."
Waivers and the process for granting them
White took issue with those criticizing how waivers from disqualifications are reviewed and decided. "Some have said that the Commission and its staff routinely grant waivers without rigorous analysis," she said. "That simply is not true."
Waivers from disqualifications follow "a thorough, rigorous and principled application of the law to the particular facts in each case and a process that we continue to scrutinize and enhance," she said. "It is not at all a routine or kneejerk exercise."
Piwowar’s point, however, was that Commissioners were ignoring staff guidelines in the granting of waivers. "For many of these waiver requests, guidelines and policies have been developed by the staff to determine if the applicants should be granted a waiver from the applicable disqualification," he said. "However, recently and with increasing frequency, Commissioners have been ignoring the established staff guidelines and staff’s efforts to apply them." While Piwowar acknowledged that the Commission is not bound to staff guidelines, "nevertheless it is important that there be an established policy or guidelines that would allow a party to determine if it would be eligible for applicable waivers."
Summarizing her explanation of the SEC’s waiver process, White said that "denying a company a waiver under circumstances where the applicable legal standards to grant it are satisfied would be a miscarriage of duty. … Granting a waiver where it is not justified would also, of course, be a miscarriage of our duty and risk harm to investors and the markets."