(Article from Registered Funds Alert, May 2015)
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Recently, the SEC’s practice of granting waivers related to various “bad actor” rules has become the center of a contentious debate among the Commissioners. Various securities law provisions provide streamlined securities offering procedures, and the “bad actor” rules restrict a party’s ability to rely on such procedures if the party has engaged in certain disqualifying conduct. One such “bad actor” provision is Section 9(a) of the 1940 Act, which disqualifies investment advisers, directors and underwriters from serving in those capacities for any registered fund if they have a relevant criminal conviction, regulatory or court order, or other disqualifying event. A party that receives a waiver would avoid disqualification and be permitted to continue serving the fund. As the SEC has stepped up its enforcement activity under Chair White’s “broken windows” approach, minor violations that result in enforcement actions or settlements may automatically result in a violation of bad actor rules. To borrow the words of SEC Commissioner Gallagher, for financial firms, failure to obtain a waiver in such circumstances could be akin to “a corporate death penalty.”
The SEC’s two non-chair Democratic Commissioners have become openly critical of how frequently bad actor waivers are granted. Last year, in connection with a waiver that was granted, Commissioner Stein dissented strongly, publicly noting her fears that the SEC “may have enshrined a new policy—that some firms are just too big to bar.” Her opinion effectively set the tone of the ongoing debate. Since then, many commentators and politicians have echoed Stein’s sentiments and have argued accusatorily that the SEC has been rubber-stamping waiver requests from large financial institutions that have faced serious or repeated enforcement actions. Commissioner Stein also recently suggested that more waivers should include conditions, such as hiring consultants.
The increasing internal and external criticism prompted Chair White to defend the bad actor waiver process in her address to the Corporate Counsel Institute on March 12, 2015. Chair White responded to Commissioner Stein directly, stating that no institution was “too big to jail or even too big to bar,” but went on to stress repeatedly that, in her view, disqualification provisions were never intended to serve as an enforcement tool or to further punish underlying criminal conduct. Rather, she argued, the bad actor rules exist to protect the public from companies that are incapable of producing reliable disclosures. In the case of large financial institutions, the actual bad actors are usually a discrete set of individuals who can be separated from the firm as part of mitigation measures.
Commissioner Gallagher also defended the SEC’s current practices and provided a useful history of bad actor provisions in a speech on February 13, 2015. He noted that the first bad actor rule was implemented in 1936, and the legislative history of later bad actor provisions shows a clear Congressional intent to keep “so-called ‘bad actors’ out of the industry, thereby preventing fraud.” Commissioner Gallagher argued that the legislative history also demonstrates that the bad actor provisions are intentionally overbroad, which is why Congress allowed waivers to be granted in the first place. Further, when Congress expanded the SEC’s sanctioning powers in 1990, disqualification waivers do not appear to have been considered. Thus, he argued, waivers should be granted “to those persons who are unlikely to abuse that relief through fraudulent or other improper conduct” and were never intended to be considered as part of the SEC’s sanctions process. Commissioner Gallagher noted that the SEC Enforcement Division has adopted “an informal, non-Commission approved, practice” that prevents settlements from being conditioned upon the granting of a disqualification waiver. He took issue with this practice and stated that he will condition his vote on any enforcement proceeding on an understanding of whether a subsequent waiver will be granted.
The Commissioners’ disagreements with respect to bad actor waivers have caught Congress’s attention. A March 2015 legislative proposal floated by Representative Maxine Waters of California, the senior Democrat on the House Financial Services Committee, would rework the bad actor waiver processes to explicitly make any automatic disqualification a sanction and direct that waivers only be granted sparingly. Representative Waters’ bill has yet to be referred to committee for consideration.
Chair White’s view, along with Commissioners Gallagher and (assumedly) Piwowar, represents the majority position at this time. That said, companies seeking a waiver should take care to distinguish themselves from what she views as true bad actors by fully describing any remedial activities they have taken and explaining why, looking forward, the company will be able to produce reliable financial disclosures.