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August 21, 2017

The SEC Has Abused Its Authority in Granting Statutory Disqualifications

When writing the laws governing our securities markets, Congress determined that the commission of certain illegal, fraudulent, or criminal acts should trigger not only fines, restitution orders, and injunctions, but also automatic disqualification from certain regulatory privileges.  So, firms that violate the law lose the privilege of raising capital through streamlined private offerings and are prevented from taking advantage of regulatory shortcuts ordinarily enjoyed by “well-known seasoned issuers.”  Congress adopted these automatic disqualification provisions, and strengthened them in 2010[1] with good reason: to protect investors, deter misconduct, reduce recidivism, promote market integrity, and remove bad actors from the markets. 

However, Congress also granted general, discretionary authority to the Securities and Exchange Commission to waive these automatic disqualifications, if upon a showing of good cause, the SEC finds that waiver is in the public interest and consistent with the protection of investors.[2]  In deciding whether to issue a waiver, the Commission is supposed to consider the facts and circumstances of each case.[3]

Unfortunately, the SEC has come to abuse this discretionary authority, granting waivers as a matter of course, with little showing of good cause, and often to firms with long rap sheets for the same or similar prior violations.  The vast majority of these waivers are granted to large corporations who have violated laws and rules but want to maintain their status on par with law-abiding companies.  A December 2014 study that found that the SEC disproportionately granted 82% of waivers to large financial firms during the preceding eleven years.[4]  What’s worse is that the SEC has not denied even one waiver request from any large firm, as if to prove that these firms are simply too-big-to-bar.   

Not everyone at the SEC has agreed with this harmful policy.  SEC Commissioner Kara Stein has more than once decried the Commission’s willingness to grant waivers to firms guilty of the most egregious criminal violations or those with a long history of illegal conduct.  As she explained in one case, “This type of recidivism and repeated criminal misconduct should lead to revocations of prior waivers, not the granting of a whole new set of waivers.  We have the tools, and with the tools the responsibility, to empower those at the top of these institutions to create meaningful cultural shifts, yet we refuse to use them.”[5] 

The SEC’s practice of readily granting waivers to all large corporations causes harm in several important ways:  It subverts Congress’s decision to disqualify these firms from receiving lighter regulatory oversight and being subject to fewer disclosure requirements; it exposes investors to further abusive conduct by the same firms and others, since it in effect removes a deterrent; and it erodes confidence in the effectiveness of the SEC as regulator and enforcer.

There are some straightforward ways to improve the entire waiver process at the SEC so that it is more selective and more transparent.  Some of them are captured in a bill introduced by Rep. Maxine Waters, which would:

  • Require the waiver process to be conducted and voted on at the Commission level, rather than at the staff level as done now;
  • Strengthen the requirement that the Commission consider the public interest and other factors when deciding whether to grant a waiver;
  • Require the Commission to publish notice and afford the public an opportunity to comment and present their views at a public hearing on whether a particular waiver should be granted or denied; and
  • Require the SEC staff to keep complete, public records of all waiver requests (formal and informal) and create a public database of all disqualified bad actors.

Perhaps the SEC itself, under Chairman Jay Clayton, who has vowed to prioritize enforcement and rid the markets of bad actors, will put a stop to the mindless waiver process that has taken root at the agency.  However such change is effected, it would be an important step toward instilling regulatory discipline by denying the “good housekeeping” imprimatur to repeat law-breakers, especially among the largest and most powerful firms.   


[1] See Sec. 926 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, disqualifying felons and other bad actors from using the Regulation D, Rule 506 private offering privileges.

[2] See, e.g., 15 U.S.C § 78mm.

[3] 17 C.F.R. § 230.506 9 (bad actor disqualification under Rule 506 may not apply if Commission determines that it is not necessary under the circumstances).

[4] See Professor Urska Velikonja, Emory University School of Law, “Waiving Disqualification: When Do Securities Law Violators Receive a Reprieve?” Working Paper, available at <http://papers.ssrn.com/abstract=2563726>.

[5] See Commissioner Stein’s dissent in a 2015 case when the SEC granted waivers to UBS, JP Morgan Chase, and Barclays and RBC, despite their having pled guilty of manipulating the LIBOR. <https://www.sec.gov/news/statement/stein-waivers-granted-dissenting-statement.html>.

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