Big Banks Could Be in Danger of Losing Securities Registration Exemptions

When a big bank or large financial firm breaks the law, should the institutional punishment be extended to how it can register securities offerings? That question has sparked a war of words at the Securities and Exchange Commission and the eventual answer could be a game-changer for firms that benefit from a longstanding registration exemption.

Refusing the exemption for banks that have settled charges stemming from actions during the financial crisis could also finally offer regulators a way to hold those banks responsible for their actions, some argue.

In 2005, the SEC gave the nation's largest public companies the opportunity to register as “Well-Known Seasoned Issuers,” or WKSIs, and gain nearly instant access to capital markets without the delays of a traditional registration process. Shelf registration statements, which allow for greater flexibility for when and how securities are issued, can take effect automatically and immediately, without the need for SEC staff review. To be eligible for this expedited WKSI status, an issuer must be up-to-date with all other reporting requirements and have at least $700 million of worldwide public common equity float. 

There is a catch. WKSI status may be revoked when an issuer violates federal securities laws or enters into a settlement of SEC charges. The SEC's Division of Corporation Finance will, however, allow waivers that allow companies to maintain their WKSI status even if they have had recent violations or have settled charges.

Such waivers, routinely granted and only rarely denied in recent years, are at the center of a debate that pits SEC commissioners against each other. While the threat of losing this special status was intended as yet another incentive for issuers to maintain effective compliance programs and squash malfeasance, lest they be put at a disadvantage among their peers, the current discussion revolves around whether the waiver process needs to be even more punitive and enforcement-minded.

SEC Commissioner Kara Stein touched off the debate when she objected to a waiver that was ultimately granted to Royal Bank of Scotland. In January, a subsidiary of RBS was criminally convicted for manipulating the London Interbank Offered Rate. The criminal conviction automatically precluded RBS from WKSI eligibility, forcing it to ask the Commission for a waiver that would allow it to retain the special status.

Since the inception of WKSIs, SEC Commissioners had not granted a waiver for criminal misconduct, Stein said in a statement. Last fall, that changed when staff granted a waiver to another large issuer, UBS, despite charges of criminal wrongdoing. The SEC has since “compounded that error” and granted other waivers for “criminal wrongdoers,” she said.

The problem with the current policy, when dealing with criminal or civil misconduct, is that it “rests largely upon the notion that the triggering conduct is insignificant when considered in the context of a large financial institution with global operations,” Stein said. “Large institutions should be treated no differently, neither better nor worse, than small and medium-sized issuers.”

Since 2010, the Commission has granted at least 30 WKSI waivers. Twenty-nine of them went to large financial institutions and broker-dealers. In many cases, these issuers are receiving their second, third, and even fourth WKSI waiver in less than four years. One large financial firm alone, in a 10-year period, has received over 22 different waivers, Stein says.

The SEC eventually approved the RBS waiver, with only Stein and Commissioner Luis Aguilar objecting. “Say what you will about how isolated or insignificant this conduct was within the context of the entire institution, it still managed to wreak havoc on financial markets across the globe,” Stein said. “Yet we provide our implicit Good Housekeeping Seal of Approval and tell the investing public that this issuer is still deserving of reduced Commission review and subject to fewer investor protections.”

SEC Commissioner Daniel Gallagher—who along with Chairman Mary Jo White and Michael Piwowar supported the RBS waiver—says that doing so was appropriate. “Philosophically, the punishment-focused view of WKSI waivers is even more troubling,” he said in a statement responding to Stein's concerns.

Privilege or Punishment?

Waiver reviews are based on the reliability of the issuer's current and future disclosure, Gallagher explained. If the misconduct that triggered the disqualification does not affect the issuer's disclosure, then granting a waiver is appropriate, he said.

He acknowledged that his view is in tension with a different perspective:  that WKSI status is a privilege, and disqualification for bad actions is an appropriate punishment. That particular view emerged in two recent pieces of guidance from the SEC's Corporation Finance Department—one in March, the other in April just one day before the RBS decision—that placed a greater burden on issuers to show why WKSI disqualification for a criminal or civil sanction may not be appropriate.

“Large institutions should be treated no differently, neither better nor worse, than small and medium-sized issuers.”

—Kara Stein,

Commissioner,

Securities and Exchange Commission

Misconduct is appropriately punished through the criminal or civil enforcement process, Gallagher argued. The question of whether to grant a WKSI waiver should be “a dispassionate analysis, undertaken by the technical experts in the Division of Corporation Finance, separate and apart from the enforcement process.”

This debate may not remain within the SEC's walls much longer. The RBS waiver has drawn attention from Capitol Hill, in particular Sen. Elizabeth Warren (D-Mass.). “When the SEC waives automatic penalties for criminal misconduct by the largest banks, it sends a dangerous signal about how weak it is in its enforcement of the law,” she says. “We are still paying the price for a financial crisis that was caused in part by regulators looking the other way while big financial institutions broke the law. Big corporations should not get special treatment when they break the law, and the SEC needs to learn from its past failures in oversight, to demonstrate no one is above the rules, and to show some backbone.”

While politics and process are debated in Washington, what do WKSI issuers need to consider? First, they will want to familiarize themselves with the recent CorpFin guidance, especially the April update clarifying the criteria for a waiver. “The most recent guidance was very explicit,” says Laura Richman, a member of the corporate and securities practice at law firm Mayer Brown. “The issuer's burden to show that the waiver is warranted is greater when a criminal conviction exists.”

Among the now-specified criteria for a waiver request is an explanation of how widespread or isolated malfeasance was. “When you put together a waiver request, CorpFin wants to know who is responsible for the problem,” Richman says. “What was the duration of the misconduct? Were there remedial steps? Is the loss of the waiver a disproportionate hardship in light of the nature of the issuer's misconduct?”

WHAT GOES INTO A WKSI WAIVER?

The following is from the “Revised Statement on Well-Known Seasoned Issuer Waivers” issued by the Securities and Exchange Commission's Division of Corporation Finance on April 24, 2014, providing details on the framework for determining waivers.

The Division will consider the nature of the violation or conviction and whether it involved disclosure for which the issuer or any of its subsidiaries was responsible or calls into question the ability of the issuer to produce reliable disclosure currently and in the future. In addition, the Division will review whether the conduct involved a criminal conviction or scienter based violation, as opposed to a civil or administrative non-scienter based violation. Where there is a criminal conviction or a scienter based violation involving disclosure for which the issuer or any of its subsidiaries was responsible, the issuer's burden to show good cause that a waiver is justified would be significantly greater.

The Division will also consider these factors when it evaluates the appropriateness of granting a waiver from ineligible issuer status.

Who was responsible for, and what was the duration of the misconduct? Specifically, the Division would consider who was responsible for the misconduct and whether it was known by the WKSI parent or whether personnel at the WKSI parent ignored warning signs regarding the misconduct.

What remedial steps did the issuer take?

CorpFin will weigh the severity of the impact on the issuer if the waiver request is denied and weigh any such impact against the facts and circumstances relating to the criminal conduct to assess whether the loss of WKSI status would be a disproportionate hardship in light of the nature of the issuer's misconduct. It will also look at any effects that the loss of WKSI status could have for the markets as a whole and the investing public.

Source: SEC.

The timing of the most recent guidance has some, including Amy Greer, co-leader of law firm Reed Smith's securities litigation and enforcement practice, wondering if it was intended to send a message. “We waited for three years for updated guidance and then, suddenly, we have two pieces of guidance a month apart,” she says. “It is pretty clear that the April guidance was intended to say, ‘If you didn't get it the last time around, we are tougher now.'”

With heightened scrutiny, firms will need to devote even greater attention to their compliance efforts and there must be support from C-suite leadership and directors for that program, otherwise their full access to capital markets is at risk, Richman says.

“It's another reason to have a robust compliance program,” she says. “If something goes wrong, you can quickly find out about it, minimize the duration, determine who was responsible, and take remedial steps. To make your case, if something does go wrong, you will want to take a look at your compliance system, see if there are additional steps you need to take, and what you can do to establish that this is not going to happen again.”

In the meantime, WKSI issuers will need to bask in the uncertainty of the current debate. “Previously, the expectation was that you could anticipate that a waiver would be granted,” says Greer, former chief litigation counsel for the SEC's regional office in Philadelphia. “Now, in this environment where the politics of it all seems to be front and center, it's a much more complicated analysis. The additional uncertainty is very troubling.”

“I suspect that the last thing the Enforcement Division needs is another hurdle to resolving cases—and yet, here we have another one,” she adds, suggesting that firms once willing to negotiate a resolution may be forced to fight instead because of the risk to raising capital.