When a big bank or large financial firm breaks the law, should the institutional punishment be extended to its ability to register securities offerings and access capital markets? In recent years, that question has sparked a war of words at the Securities and Exchange Commission, but we may be on the cusp of greater clarity (and perhaps yet another wave of controversy) regarding the effect of enforcement actions on registration exemption.

SEC Chairman Jay Clayton, in a public statement last week, argued that qualifications for certain waivers might no longer be delayed due to lingering accusations of misconduct.

Provisions in securities laws allow law-abiding companies to engage in activities with less oversight, fewer disclosure requirements, and limited liability. Companies that violate federal securities laws or enter into a settlement of SEC charges, however, can lose their Regulation A and Regulation D exemptions for Rule 506 eligible private placements, as well as the opportunity to register as “well-known seasoned issuers,” or WKSIs, to gain nearly instant access to capital markets without the delays of a traditional registration process.

Shelf registration statements, which allow for greater flexibility for when and how securities are issued, can take effect automatically and immediately, without the need for SEC staff review.

A WKSI issuer, for example, does not have to wait for the Division of Corporation Finance to review and declare a registration statement effective prior to selling financial products to investors.

The SEC’s approach to WKSI waivers has long led to strife among commissioners, with a debate over whether misconduct unrelated to securities sold to investors should trigger a WKSI ban or whether doing so is an ill-advised enforcement tool contrary to the interests of investors.

To be eligible for this expedited WKSI status, an issuer must be up-to-date with all other reporting requirements and have at least $700 million of worldwide public common equity float. There is a catch: WKSI status may be revoked when an issuer violates federal securities laws or enters into a settlement of SEC charges. The SEC’s Division of Corporation Finance will, however, allow waivers that let companies maintain their WKSI status even if they have had recent violations or have settled charges. A similar waiver process applies to companies that could otherwise lose their Regulation A and Regulation D exemptions.

Clayton wants the Commission to less frequently link enforcement actions to waiver issuance.

“The Commission has long recognized that an appropriately crafted settlement can be preferable to pursuing a litigated resolution, particularly when the settlement is agreed early in the process and the [SEC] obtains relief that is commensurate with what it would reasonably expect to achieve in litigation,” Clayton said just before the July 4 holiday. ”In plain language, the sooner harmed investors are compensated, the offending conduct is remediated, and appropriate penalties are imposed, the better. I have been considering the factors that affect settlement negotiations and settlement agreements with an eye toward enhancing outcomes for investors and most effectively utilizing our resources.”

Clayton addressed the Commission’s approach to settlement offers that are “accompanied by contemporaneous requests for Commission waivers from automatic statutory disqualifications and other collateral consequences.” A factor that drives appropriate settlements, he explained, is “the importance of promptly remedying harm to investors.” Another factor that drives appropriate settlements is a desire for certainty.

“Put simply, the Commission’s willingness to zealously pursue all appropriate remedies often is a strong stick and, at the same time, the ability of the Commission to provide a full and final resolution of a matter often is a significant carrot,” he said.

Complexity and waivers

Clayton observed that enforcement remedies, such as the imposition of an injunction against future violations of the antifraud provisions of the federal securities laws or the requirement that an entity retain an independent compliance consultant, may subject an entity to collateral disqualifications that, as a practical matter, can prohibit it from continuing to conduct certain businesses. “The effects of these collateral consequences can vary widely depending on the scope of the businesses and operations of the entity and, in practice, range from immaterial to extremely significant,” he said.

Therein lies an ongoing debate about whether the Commission should grant certain waivers amid an unconnected discovery of malfeasance.

Back in May 2015, for example, the SEC agreed not to let accusations of LIBOR manipulation lead to the revocation of Deutsche Bank’s WKSI status. The decision was detailed in a no-action letter.

Deutsche Bank and a U.K. subsidiary, DB Group Services, had pleaded guilty to wire fraud for their role in manipulating the London Interbank Offered Rate, agreeing to pay $775 million in criminal penalties to the Department of Justice. That brought the total amount of penalties against the bank to $2.5 billion following similar settlements with the Commodity Futures Trading Commission, New York’s Department of Financial Services, and the U.K. Financial Conduct Authority. From 2003 through early 2011, numerous Deutsche Bank derivatives traders engaged in various schemes to move benchmark rates in a direction favorable to their trading positions.

Lacking a waiver from the SEC, this illegal activity would have otherwise triggered the automatic “bad actor” revocation of Deutsche Bank’s WKSI status, a costly punishment.

The SEC’s approach to WKSI waivers, in this case and others, has long led to strife among commissioners, with a debate over whether misconduct unrelated to securities sold to investors should trigger a WKSI ban or whether doing so is an ill-advised enforcement tool contrary to the interests of investors.

“With these advantages comes a modicum of responsibility,” former Commissioner Kara Stein said at the time. “WKSIs must meet the very low hurdle of not being ineligible.”

Deutsche Bank’s illegal conduct “involved nearly a decade of lying, cheating, and stealing” and “was pervasive and widespread,” she said. Also, Stein added, Deutsche Bank “is a recidivist, and its past conduct undermines its current promise of future good conduct.”

Since 2004, it had, among other violations, a criminal admission of wrongdoing connected to promoting tax shelters, a settlement involving misleading investors about auction rate securities, and a violation against its investment bank for improperly asserting influence over research analysts. Deutsche Bank has nevertheless requested, and received, three WKSI waivers in eight years.

“It is safe to assume that these waiver requests will continue to roll in, as issuers are now emboldened by an unofficial Commission policy to overlook widespread and serious criminal conduct,” Stein said.

For its part, Deutsche Bank argued at the time that none of the LIBOR-related conduct pertained to its role as an issuer of securities. “The Department of Justice did not conclude that the directors or senior officers of Deutsche Bank engaged in any deliberate misconduct or were aware of violative conduct or ignored any warning signs or ‘red flags’ regarding the conduct.” Its request for a waiver cited “extensive steps to remediate the misconduct and strengthen its compliance and internal control standards.”

This sort of scenario would be decidedly more business-friendly under Clayton’s newly outlined policy clarification. “In many cases, the Commission has the authority to grant a waiver from these collateral consequences, either in full or subject to conditions. In these circumstances, parties seeking settlements often make contemporaneous settlement offers and waiver requests,” he said.

The Commission has followed a practice in which a decision to grant, deny, or condition the grant of a waiver is informed by a recommendation from one or both of the Divisions of Corporation Finance and Investment Management or determined by the staff pursuant to the delegated authority. “Considering a settlement offer and a related waiver request as if they are two separate and unconnected events can add complexity, including because such a formulaic separation often is inconsistent with appropriate consideration of the substance and interconnected nature of the matters at issue and undermines factors that drive appropriate settlements,” Clayton said. “The 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.”

Settlement offers and waiver requests

Under Clayton’s plan, 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.

An offer of settlement that includes a simultaneous waiver request negotiated with all relevant divisions (Enforcement, Corporation Finance, Investment Management) will be presented to and considered by the Commission as a single recommendation from the staff. “This approach will honor substance over form and enable the Commission to consider the proposed settlement and waiver request contemporaneously, along with the relevant facts and conduct, and the analysis and advice of the relevant Commission divisions to assess whether the proposed resolution of the matter in its entirety best serves investors and the Commission’s mission more generally,” he said.

What Clayton views as offering greater clarity could nonetheless backfire and reignite controversies about how the waiver process does, or should, intersect with enforcement actions.

Congresswoman Maxine Waters (D-Calif.), now chairman of the House Committee on Financial Services, previously introduced the Bad Actor Disqualification Act of 2017. The bill, which stalled in the House, would have ensured the SEC “protects investors from bad actors by implementing a rigorous, fair, and public process for waiving automatic disqualification provisions in the law.”

“By waiving the consequences for bad actors, the SEC is sending the wrong message,” Waters said at the time. “The SEC should not automatically give those who break the law a free pass by allowing them to continue to conduct business as usual.”