In Significant Shift, SEC Will Consider Offers Of Settlement And Collateral Waiver Applications Together
On July 3, 2019, Chairman Jay Clayton of the Securities and Exchange Commission (“SEC”) issued a Statement Regarding Offers of Settlement (the “Public Statement”) to announce a significant shift in the SEC’s process of considering settlement offers and requests to waive collateral consequences of such settlements. SEC Public Statement, Statement Regarding Offers of Settlement (2019). Chairman Clayton stated that he recognized “that a segregated process for considering contemporaneous settlement offers and waiver requests may not produce the best outcome for investors in all circumstances,” and thus announced “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.” Id.
Chairman Clayton emphasized in the Public Statement the importance of an “appropriately-crafted settlement,” and noted several factors that drive the Commission’s settlement decisions, including: 1) cost of litigation, 2) “demonstrated willingness of the Commission to litigate zealously if a timely and reasonable offer of settlement is not made,” 3) “importance of promptly remedying harm to investors,” and 4) the “desire for certainty.” Id. But the focus of Chairman Clayton’s statement was on this last factor, the “desire for certainty,” which he recognized is complicated by the potential collateral consequences an entity may face after settling an enforcement action. In the hope of reducing this uncertainty, he made 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.” Id.
Successful enforcement actions brought by the SEC can automatically trigger significant collateral consequences for the settling entity, often extending far beyond the scope of any sanctions imposed in the enforcement action itself. These collateral consequences can include: (1) loss of well-known seasoned issuer status for the purposes of securities offerings; (2) disqualification under Section 9(a) of the Investment Company Act of 1940, which bars the affected entity and its affiliates from serving as an investment adviser, depositor or principal underwriter of certain registered investment companies; (3) loss of statutory safe harbors under the Securities Act of 1933 (“Securities Act”), and the Securities Exchange Act of 1934, for forward-looking statements; (4) loss of private offering exemptions provided by Regulations A and D under the Securities Act; (5) loss of the exemption from registration under the Securities Act for securities issued by certain small business investment companies and business development companies provided by Regulation E; and (6) the prohibition on a registered investment adviser from receiving cash fees for solicitation under Rule 206(4)-3 of the Investment Advisers Act of 1940.
While otherwise automatic, the SEC has the ability to waive these collateral consequences when requested if it is “necessary or appropriate in the public interest, and is consistent with the protection of investors.” See 15 U.S.C. § 78mm(a)(1). But historically, firms had to negotiate and apply for these waivers independent of any negotiations regarding the underlying enforcement action that triggered the disqualifications. That created significant uncertainty for firms, making it difficult in many instances to assess whether or not it made sense to settle a threatened enforcement action.
According to the Public Statement, going forward, the Commission will consider an offer of settlement that includes a simultaneous request for a waiver of collateral consequences negotiated with the relevant divisions, as a single recommendation from the division’s staff. This new approach will allow the Commission to consider the holistic circumstances of the matter in its settlement approval procedures. Chairman Clayton did make clear, however, that the Commission may still approve a settlement without the waiver, in which case the entity involved would need to promptly notify the Commission of its decision to move forward (or not move forward) with the accepted portion of the settlement.
While it remains to be seen whether this shift will alter the Commission’s approach to waivers as a substantive matter, it is unquestionably a very welcome shift as a procedural matter, affording a more fair and reliable process for settling defendants without any apparent downside to the SEC or the public. Firms will now be far more able to assess the true consequences of a proposed settlement, and thus will be better positioned to decide whether, and when, to resolve threatened SEC enforcement actions.