In one of her first official actions as Acting Chair of the Securities and Exchange Commission (SEC or Commission), Allison Herren Lee reversed a major policy implemented by recently departed SEC Chairman Jay Clayton involving the SEC enforcement settlement process. This decision could significantly impact the SEC settlement process by causing uncertainty for settling entities as to the business consequences of a settlement. In a rare rebuke, two fellow SEC Commissioners promptly issued a statement decrying the Acting Chair's decision.
Collateral Consequences of SEC Settlements
The federal securities laws contain provisions that impose restrictions on entities found to have violated certain statutes or regulations or that become subject to certain court-imposed injunctions or administrative orders. These restrictions, commonly referred to as "collateral consequences," range from prohibiting a settling entity (and possibly its affiliates) from taking advantage of certain exemptions under the federal securities laws to disqualifying an entity from engaging in specific business activities. SEC settlements regularly trigger collateral consequences against settling SEC-regulated entities, like broker-dealers, hedge funds, investment advisers, and public companies. For example, a public company issuer that settles with the SEC could be automatically disqualified from being considered a Well-Known Seasoned Issuer under Rule 405 of Regulation C. Alternatively, a settlement could prohibit a settling investment adviser from providing advisory services to an investment company or from receiving cash fees for solicitations.
Given the serious collateral consequences an SEC settlement can trigger, and the fact that such consequences often are unrelated to the misconduct at issue in the corresponding SEC settlement, the SEC is authorized to grant disqualification waivers. The SEC routinely grants waivers to prevent disproportionate and unintended consequences resulting from a settlement.
Naturally, settling parties desire certainty regarding the collateral consequences of a settlement they are contemplating. To that end, settling parties seek to secure disqualification waivers that become effective contemporaneous with their settlements. For quite some time, the Commission had considered the settlement and waiver processes almost exclusively on a separate basis. Generally, settling parties would seek support from the SEC Staff for waivers that would offset the consequences of a proposed settlement, but the Commission would not consider the waivers until the settlement was executed (at which time the consequences had already been triggered).
Contingent Settlement Process
Critics of this bifurcated process — including defense counsel, settling entities, and SEC Commissioners — contended that it unnecessarily hindered and complicated SEC settlements by creating uncertainty for settling parties. Former SEC Chairman Clayton commented that "[t]he complexity added by such a separation can substantially complicate and lengthen the negotiating process, which, among other consequences, may not lead to the best outcome for investors and can unnecessarily tap Commission resources." These concerns prompted Chairman Clayton to announce a major change in the SEC's waiver application process in July 2019. Specifically, Chairman Clayton declared that a settling entity can request the SEC to consider an offer of settlement that addresses both the underlying enforcement action and any related collateral disqualifications. Following this announcement, the SEC considered settlement offers and waiver requests together and settling entities submitted settlement offers contingent on the SEC graining them waivers.
Uncertainty has now returned for settling entities due to the dueling statements issued last week by Acting Chair Lee and Commissioners Hester Peirce and Elad Roisman. On February 11, Acting Chair Lee announced the decoupling of the settlement and waiver processes, explaining that "the Division of Enforcement would no longer recommend to the Commission a settlement offer that is conditioned on granting a waiver" and that the determination on granting waivers "should be made separately . . . from considerations related to the settlement of an enforcement case." One day later, Commissioners Peirce and Roisman issued a surprising statement disagreeing with Acting Chair Lee's rescission of the policy of considering and accepting contingent settlement offers, stressing that the "policy worked well."
Practical Implications
Despite the objections of Commissioners Peirce and Roisman, it appears that the new policy implemented by Acting Chair Lee now governs the SEC settlement process. Therefore, a settling entity likely will be unable to condition a settlement offer on the SEC granting it a waiver(s). In this new environment, if an entity deems a disqualification waiver crucial to its settlement, we recommend that its counsel start a dialogue early with the SEC Staff. Waivers often involve coordination between the SEC's Enforcement Division and at least one other Division, which can delay the process. Accordingly, starting the waiver process early increases the likelihood that a waiver is granted simultaneous with, or at least soon after, entry of the settlement order. Finally, in the event a settling entity knows there will be a gap in time between imposition of its settlement order and the granting of a waiver, it should work with counsel to develop a plan to comply with the disqualification provisions during the time gap.
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