Tuesday, August 01, 2017

Rep. Waters to introduce SEC bad actor bill

By Mark S. Nelson, J.D.

House Financial Services Committee Ranking Member Maxine Waters (D-Calif) plans to introduce a bill that would reform the SEC’s bad actor waiver process. The bill would include a sense of Congress stating that automatic disqualifications deter securities fraud, but that current SEC practice skews the waiver process in favor of grants to large firms without adequate transparency. The Waters bill contrasts with provisions contained in the Financial CHOICE Act of 2017 that would eliminate many automatic disqualifications.

Too-big-to-bar. Waters said the Bad Actor Disqualification Act of 2017 is needed to ensure the SEC is accountable for its waiver decisions. “The SEC should not automatically give those who break the law a free pass by allowing them to continue to conduct business as usual,” said Waters. “This commonsense legislation will subject waiver requests to public scrutiny and robust SEC review so that the law protects investors, the markets, and the public. No one is above the law, including large financial firms.”

Waters also noted in a bill summary that waivers tend to be granted in favor of the largest firms resulting in an implicit “too-big-to-bar” scenario. Despite more recent changes to the Commission’s waiver process, Waters said not enough had been done to eliminate defects in that process, which Waters said had been highlighted in Commissioner Kara Stein’s 2014 dissent from a waiver granted to Royal Bank of Scotland Group, plc.

Waiver procedure. The bill would establish a process for an ineligible person to obtain a temporary or general waiver. Significantly, the bill would shift accountability from the SEC staff level to the Commission by requiring commissioners to vote on waiver petitions.

The Commission could grant a single, 180-day temporary waiver upon determining that a petitioner had demonstrated immediate irreparable injury. The Commission would then publish the petition and an order explaining its vote.

The Commission could then consider a general waiver, but may not vote to waive a disqualification unless it determines that the waiver is in the public interest, is necessary for the protection of investors, and promotes market integrity. The Commission’s determination must not consider the “direct costs” of a denial to an ineligible person.

A general waiver would be published in the Federal Register so the public can offer views at a hearing or otherwise. SEC staff also would be prohibited from having advance discussions with anyone regarding a recommendation to the Commission that a waiver be granted or denied.

“Ineligible person” is used throughout the draft legislation. The term is defined with reference to a variety of securities laws and regulations, including:
  • Securities Act Rule 405—Ineligible issuer not eligible to be a well-known seasoned issuer; 
  • Securities Act Rules 505 and 506—Regulation D private offering exemptions; 
  • Securities Act Section 27A(c) and Exchange Act Section 21E(c) —Safe harbor for forward-looking statements;
  • Investment Advisers Act Rule 206(4)-3—Denial of cash fee for adviser solicitation activities; 
  • Securities Act Rule 262—Regulation A exemptions; and
  • Securities Act Rule 602—Regulation E exemptions. 
Waiver data. The Commission would be required to maintain and publish records of withdrawn waiver requests under the Waters bill. The Commission also would have to establish a database of ineligible persons for whom a wavier was denied or who made a disclosure to the Commission indicating their ineligibility.

GAO study. The GAO would be tapped to perform a study of waivers of automatic disqualifications in the context of investment companies. The GAO, among other things, would be asked to compare Investment Company Act and Exchange Act provisions. The GAO also would make recommendations for improving the transparency of the waiver process for investment companies and for increasing public participation regarding waivers.

CHOICE Act. Section 827 of the Financial CHOICE Act (H.R. 10) would remove many automatic disqualifications by providing, in part, that a non-natural person cannot be disqualified or made ineligible to use exemptions or registration provisions unless the Commission holds a hearing and determines that the non-natural person should be disqualified or ineligible. The provision would alter much of the work the Commission was required to do by Dodd-Frank Act Section 926, with an implicit reference to lawmakers’ earlier attempts via the crowdfunding title of the Jumpstart Our Business Startups (JOBS) Act, to leverage Regulation A’s Rule 262 for purposes of conforming the various bad actor provisions across the securities laws.

The CHOICE Act is the Republican-led effort to revise the Dodd-Frank Act that passed the House in June, and from which selected provisions may yet be attached to appropriations bills. This is the CHOICE Act’s second go-around, after having been first introduced during the Obama Administration when it would have faced a presidential veto. House Financial Services Committee Chairman Jeb Hensarling (R-Texas), sponsor of the CHOICE Act, has said the bill would broadly meet the principles of financial reform developed by the Treasury Department in response to a request by President Trump.

By contrast, Michael Rothman, president of the North American Securities Administrators Association, Inc., called Section 827 “baffling and misguided” in a statement to the House Financial Services Committee in advance of the House vote on the CHOICE Act. “If enacted, this provision would create procedural burdens to necessary disqualifications, allowing bad actors to continue to rely on exemptions, registrations, and activities that led to those bad acts.”