SEC Returns to More Pragmatic Approach to Settlement Consequences

Parties considering a possible settlement of a matter before trial usually weigh factors such as the likelihood of success on the merits, litigation costs and distractions, and the expected monetary value of potential trial outcomes. But parties facing US Securities and Exchange Commission (“SEC” or the “Commission”) enforcement actions also must anticipate and evaluate the unique collateral consequences that may result from any settlement or adverse litigation result. On July 3, 2019, SEC Chairman Jay Clayton issued a statement announcing the Commission’s revised approach to considering whether the Commission, as part of a proposed settlement, will waive those collateral consequences.¹

As one example, certain issuers—well-known seasoned issuers (WKSIs)—enjoy certain capital-raising advantages, such as the ability to file shelf registration statements that are automatically effective. An issuer is WKSI-ineligible if, within the past three years, the issuer or any of its subsidiaries has been the subject of certain actions or orders, such as an SEC enforcement action that resulted in an anti-fraud federal court injunction or an SEC cease-and-desist order. The SEC may waive WKSI ineligibility “for good cause,” a standard that leaves substantial room for the agency’s discretion.²

Prior to Chairman Clayton’s announcement, an entity seeking a waiver would submit an application to the relevant Division of the SEC, either the Division of Corporation Finance (CorpFin) or the Division of Investment Management (IM). CorpFin or IM staff—after considering, among other things, the application, the conduct alleged in the settlement papers, and any previous relevant conduct by the entity—decide whether to recommend that the Commission grant the waiver. That recommendation and the application would be presented to the Commission for its consideration and vote.

Because the waiver application process often followed the resolution of an enforcement action, this process created uncertainty. And it was not fair to the applicant, which had to decide whether it wanted to settle on the proposed terms—without knowing whether CorpFin or IM would recommend a waiver, a decision with significant potential future business ramifications.

In his July 3 statement, Chairman Clayton explained that settling parties now may request that the Commission simultaneously consider the resolution of the enforcement action and any waiver request. And if the Commission approves the enforcement settlement, but denies the waiver, the applicant would have five business days to inform the staff whether it wishes to withdraw its settlement offer or settle the enforcement action without the waiver.

Significantly, Chairman Clayton’s statement does not distinguish situations where CorpFin or IM recommend or oppose a waiver. Before recommending to the Commission that an application be denied, CorpFin or IM typically informs an applicant that the Division will not support the wavier. Although an applicant may elect to proceed with its application—and ask the Commission to grant the waiver over the opposition of CorpFin or IM—most parties in that position choose instead to withdraw the application and avoid the potential public embarrassment of an SEC order denying the waiver. Although the newly announced procedure affords waiver applicants the option to withdraw their offer of settlement following a Commission denial of a waiver application, applicants will still need to weigh the risk of embarrassment if the Staff’s recommendation or the Commission denial of the application became public.

As Chairman Clayton notes, this approach is not new, but rather a return to a prior Commission practice of allowing offers of settlement contingent on a specified waiver. Companies facing potential SEC enforcement action should welcome the change as the approach provides more certainty to settling parties that risk disqualification.

The new procedures, however, do not remove all uncertainty. For example, if a WKSI-ineligible issuer (or one of its subsidiaries) is facing a second disqualifying enforcement action, the Divisions typically will not provide any guidance about whether they would—upon the expiration of the ineligibility from the first settlement—recommend a waiver of the second disqualifying event. Under such circumstances, the settling party would not know whether the proposed settlement would extend its WKSI-ineligibility.

¹ SEC Chairman Jay Clayton, Public Statement, “Statement Regarding Offers of Settlement,” July 3, 2019.

² As Chairman Clayton noted in his statement, as part of the settlement process, a party may seek a waiver or other relief from other collateral consequences that are attendant to the proposed settlement. These other collateral consequences may include the loss of statutory safe harbors for forward-looking statements, the loss of private offering exemptions, the loss of the registration exemption for securities issued by certain small business investment companies and business development companies, and the prohibition on a registered investment adviser from receiving cash fees for solicitation.