On February 11, 2021, the Acting Chair of the Securities and Exchange Commission (“SEC”), Allison Herren Lee, announced that the Division of Enforcement will no longer recommend to the SEC a settlement offer that is conditioned on granting a waiver. While Acting Chair Lee described this as a return to the SEC’s “long-standing practice” of separately considering settlement negotiations and waiver requests, Allison Herren Lee, Acting Chair, SEC, Statement of Acting Chair Allison Herren Lee on Contingent Settlement Offers
(Feb. 11, 2021), the decision is in fact a significant and surprising one that was opposed by two Commissioners and could have broad ramifications for the industry. It signals, in no uncertain terms, that the SEC is looking to be extremely aggressive in enforcement, will almost certainly be far more stingy in granting waivers in future matters, and is prepared to deal with the consequences. What remains to be seen is how the industry will respond, as the advanced assurance of waivers from the SEC is often not just a factor in a defendant’s decision to settle—for some defendants it is a critical gating item without which no settlement is possible.
Successful enforcement actions brought by the SEC can, depending on the nature of the charges and sanctions, 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). Historically, firms had to negotiate and apply for these waivers independent of any negotiations regarding the underlying enforcement action that triggered the disqualifications. But in 2019, in recognition that this situation created significant and unnecessary uncertainty for firms, then-Chairman Jay Clayton stated 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.” https://www.lit-wc.shearman.com/In-Significant-Shift-SEC-Will-Consider-Offers-Of-Settlement-And-Collateral-Waiver-Applications-Toget
In her statement, last week, Acting Chair Lee claimed that reversing the policy instituted by Chairman Clayton was appropriate because connecting the settlement negotiation and waiver request processes could cause “structural conflicts or pressures” within the SEC and emphasized that the consideration of waivers must be “forward-looking” and “focused on the protection of investors, markets, and market participants,” rather than being seen as a “bargaining chip” or “obstacle” during settlement negotiations. She also emphasized that a “waiver is not the default position under the law, and should not be considered one.”
But what is missing from Acting Chair Lee’s statement is any suggestion that the conditional settlement process instituted under Chairman Clayton has proved unworkable in any way. And that is precisely what Commissioners Hester M. Peirce and Elad L. Roisman emphasized in a statement released on February 12, 2021, responding to the announcement. Statement of Commissioners Hester M. Peirce and Elad L. Roisman on Contingent Settlement Offers
(Feb. 12, 2021); https://www.sec.gov/news/public-statement/peirce-roisman-statement-contingent-settlement-offers-021221. They stated: “The judgment of the Division of Investment Management and the Division of Corporation Finance remained fully independent of the Division of Enforcement, and the policy has not created structural conflicts or pressures between the settlement and waiver processes undertaken by the different operating divisions. In short, the policy worked well.”
What is perhaps most surprising about this announcement is the speed with which it occurred. It did not follow the solicitation of input from the industry, any public debate, or even any public incident that may have signaled internal frustration at the Commission regarding the program. Instead, it seems to be simply a policy-based reversal, implemented mere weeks after the Biden Administration began. And while policy-based changes are to be expected with every change in Administration, this appears to be one with debatable benefit. As explained by Commissioners Peirce and Roisman, conditional settlements do not in any way deprive the SEC of powers; they simply allow defendants to better analyze the consequences of settling. Having taken away that option, defendants facing a potential enforcement action that would trigger disqualifications will now have to decide whether to settle or litigate without complete information, which seems likely to lead to fewer resolutions and more litigated matters, as well as more collateral consequences for companies subject to an SEC enforcement investigation as to which there may be a good faith disagreement over whether a violation has occurred.