Waiving Disqualification: When Do Securities Violators Receive a Reprieve?

Waiving Disqualification: When Do Securities Violators Receive a Reprieve?



In addition to considerable sanctions, criminal and civil securities enforcement actions trigger an array of collateral consequences. This Article studies automatic “bad-actor” and “ineligible-issuer” disqualifications, which bar disqualified firms from relying on relaxed disclosure and reporting requirements when raising external capital. First adopted in 1940, the disqualifications were primarily intended to reduce the risk of future violations related to the sale of securities.

The SEC has the authority to waive disqualifications on showing of good cause, in particular where the defendant poses low risk of fraud in a disqualified offering. This Article reviews the population of 201 bad-actor and ineligible-issuer waivers granted between July 2003 and December 2014, and identifies three significant trends in the SEC’s exercise of waiver authority. First, large financial firms received a large majority of waivers, 81.6 percent. Smaller financial firms and nonfinancial companies rarely received waivers. The relative share of waivers issued to large financial firms is not necessarily a reason for concern if such firms are less likely to commit securities fraud than smaller and nonfinancial firms. This could be due to alternative risk-reduction mechanisms such as external oversight or superior self-policing. Second, the study finds that the SEC has developed unwritten criteria for granting waiver requests but has lacked transparency. Most significantly, firms charged with accounting fraud rarely receive a waiver, regardless of their size. But large firms charged with fraud related to structured mortgage securities do tend to receive waivers, even though such misconduct signals fraud risk. Moreover, waivers are often granted to repeat violators whose track record suggests problems with legal compliance. And third, the study reveals a shift in waiver practices over time. The number of granted waivers has declined since 2010, as scrutiny of the SEC’s waiver practices has increased. Also, the SEC recently shifted from granting waivers in full to limited and conditional waivers, a practice that is consistent with the purpose of disqualifications.

This Article proposes that automatic disqualifications can be useful tools if deployed consistently and transparently. The SEC should articulate clear and justifiable criteria for automatic disqualifications based on indicators of future fraud. It should make principled and transparent decisions on whether, when, and under what conditions to grant waivers. Disqualifications can be blunt instruments. Rather than waive disqualifications in full, the SEC should expand its practice of granting limited and conditional waivers where waiver denial would be excessive.

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