Proposed Bad Actor Disqualification Act of 2019 Would Severely Limit the Availability of Waivers for Institutions Entering into Settlements with the SEC and DOJ

July 9, 2019

Last month, Representative Maxine Waters, Chair of the House Financial Services Committee, introduced a discussion draft of the “Bad Actor Disqualification Act of 2019” (the “Proposed Act”).

Similar to proposed legislation Rep. Waters introduced in 2015 and 2017, the effect of the Proposed Act, if passed, would be to dramatically increase the burdens on institutions seeking waivers from disqualifications under the federal securities laws, including those for Well-Known Seasoned Issuers (“WKSI”), certain exemptions from registering securities offerings, and protection from fraud claims predicated on forward-looking statements.  Indeed—given that the Proposed Act would require that all waiver applications be open to public comment and hearing and vote by the Securities and Exchange Commission (“Commission” or “SEC”), and that the Commission be barred from considering the “direct costs” of a denial to the applicant, but rather only the interests of the public, investors, and market integrity—the effect may be to essentially eliminate waiver applications and grants in all but the most severe cases.  The Proposed Act targets “the largest financial institutions on Wall Street,” which, unsurprisingly given their business models, request and receive a disproportionate share of waivers.  However, by its terms the Proposed Act applies more broadly to all issuers and is not limited to financial institutions.

1. Background

The federal securities laws contain a number of provisions allowing qualifying entities certain accommodations designed to ease the burdens, including costs, time, and litigation risk, associated with issuing securities.  These include:

  • WKSI status, allowing companies to offer securities without prior review from SEC staff and the ability to use a less burdensome written communication to sell securities—a so-called “free writing prospectus.”

  • Offering exemptions provided by Regulations A, D, and E under the Securities Act of 1933 (“Securities Act”), allowing, respectively, exemptions from registration for certain smaller offerings, for limited offers without regard to dollar amount of offering, and for business development companies and small business investment companies.

  • PSLRA safe harbor that protects companies from private securities fraud liability related to their forward-looking statements, such as projections about revenue and income.

  • Receipt of cash payment from an investment adviser for solicitation activities under the Investment Advisers Act of 1940.

Broadly speaking, however, these accommodations are not available to entities that are found to have engaged in wrongdoing—including pursuant to an SEC enforcement proceeding, settled or litigated, and criminal convictions—absent a waiver from the Commission.  Under current practice, waiver applicants typically submit draft waiver requests to SEC staff in the relevant division.  Such requests are not initially made public, and the applicant can withdraw the request if the staff indicates that their division, acting by delegated authority, or the full Commission, is unlikely to grant it.  Under current law, the Commission and staff have significant discretion in determining whether to grant waivers.  For example, the SEC grants WKSI and Regulations A, D, and E waivers upon a showing of “good cause,” under which, pursuant to published guidance, it considers a number of factors, including who was responsible for the misconduct, the duration of the misconduct, what remedial steps were taken, and the effects of a denial on the waiver applicant itself, among other factors.

Please click here to read the full alert memorandum. This article was republished by the Harvard Law School Forum on Corporate Governance and Financial Regulation