Monday, July 11, 2011

SEC Staff Provides Guidance on Waivers of Ineligible Issuer Status for Well-Known Seasoned Issuers

The Division of Corporation Finance has provided guidance on what constitutes a showing of good cause for purposes of an ineligible issuer waiver for a well-known seasoned issuer. If the anti-fraud violation does not involve the issuer’s own disclosures, said the staff, a waiver request would likely be granted, even if scienter-based. But a waiver request involving a scienter-based anti-fraud violation stemming from the issuer’s own disclosures would likely not be granted. If the issuer’s antifraud violation is not scienter based and stems from its own disclosures, the staff will decide on a waiver based on factors such as remedial steps taken, the timing and pervasiveness of the misconduct, and the impact of a waiver denial on the issuer.

The Supreme Court has defined scienter as a mental state embracing intent to deceive, manipulate, or defraud. In addition, every federal Court of Appeals that has considered the issue has held that a plaintiff may meet the scienter requirement by showing that the defendant acted intentionally or recklessly, though the Circuits differ on the degree of recklessness required. Some of the anti-fraud provisions of the federal securities laws are scienter based, including, Rule 10b-5, Section 17(a)(1) of the Securities Act; Section 15(c)(1) of the Exchange Act; and Section 206(1) of the Advisers Act. Other anti-fraud provisions are non-scienter based, including Sections 17(a)(2) and (3) of the Securities Act; Section 14(a) of the Exchange Act and Rule 14a-9, Sections 206(2) and 206(4) of the Advisers Act; and Section 34(b) of Investment Company Act

In its 2005 Securities Offering Reforms the SEC created the category of the well-known seasoned issuer for the most widely followed issuers representing the most significant amount of capital raised and traded in the U.S. These issuers benefit to the greatest degree from the communications and registration flexibilities provided
in the offering reforms. Most notably, well-known seasoned issuers can register their securities offerings on shelf registration statements that become effective automatically upon filing.

Issuers that have violated the anti-fraud provisions of the federal securities laws become “ineligible issuers” and lose their well-known seasoned issuer status for three years. However, under Securities Act Rule 405, the Commission, with delegated authority to Corp Fin, may grant waivers of ineligible issuer status upon a showing of good cause.

In determining whether a waiver should be granted, the Corp Fin staff will consider two threshold factors relating to the nature of the anti-fraud violation: first, whether the anti-fraud violation stems from the issuer’s own disclosures about itself; and second, whether the anti-fraud violation is scienter-based. This approach focuses on the reliability of the issuer’s current and future disclosures. If the anti-fraud violation does not involve the issuer’s own disclosures, reasoned the staff, then it may be less likely to cast doubt on the reliability of the issuer’s current and future disclosures. In this case, a waiver request would likely be granted, even if the anti-fraud violation is scienter-based

On the other hand, if the anti-fraud violation involves the issuer’s own disclosures, then it more directly raises questions about the reliability of the issuer’s current and future disclosures. In addition, if the issuer’s conduct in making material misstatements or omissions was intentional or reckless, then the likelihood of its future disclosures not being reliable may be greater than if the conduct was not intentional or reckless. Consequently, absent exceptional circumstances, a waiver request involving an anti-fraud violation that is scienter
based and stems from the issuer’s own disclosures would likely not be granted.

If the anti-fraud violation is not scienter-based and stems from the issuer’s own disclosures, the SEC staff said that it will consider a number of factors, with no single factor being determinative. One factor is remedial measures taken to prevent a recurrence of the misconduct, including changes in key personnel and improvements to internal controls and disclosure controls. The effectiveness of these actions would help support a conclusion that, despite past violations, the issuer’s disclosures to the markets would be more likely to be reliable in the future.

Another factor is the seriousness and pervasiveness of the misconduct by the issuer and its officers, directors and employees, including the culpability of individuals and the age of the misconduct. Fraudulent conduct and disclosures resulting from the actions of a few individuals not in positions of authority could create fewer questions about the reliability of an issuer’s future disclosures than a history of misconduct by senior management or a culture or tone at the top demonstrating a lack of commitment to good disclosure.

The SEC staff will also weigh the severity of the impact on the issuer if the waiver request is denied against the facts and circumstances of the anti-fraud violation to assess whether the loss of well-known seasoned issuer status would be a disproportionate hardship in light of the nature of the issuer’s misconduct. More broadly, the staff will examine whether the issuer’s loss of well-known seasoned issuer status could have harmful effects for the markets as a whole, in light of the issuer’s significance to the markets and its connectedness to other market participants.

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