We have previously blogged about the SEC’s July 2013 rule change that disqualifies certain “bad actors” from using Rule 506. Thankfully, Rule 506 permits the SEC to determine, upon a showing of good cause, that it is not necessary under the circumstances to deny availability of Rule 506. The SEC has recently issued a policy statement explaining how it will evaluate whether a party seeking a waiver has shown good cause that it is not necessary under the circumstances that the exemptions be denied.

Background

Other securities offering exemptions, including Rule 505 and Regulation A, have had bad actor disqualifications for many years, and the SEC has also had the authority to grant waivers under these exemptions using a similar “good cause” standard. In fact, based on this interesting article from Urska Velikonja, the SEC granted waivers nearly 200 times between July 2003 and December 2014. However, because Rule 506 is so much more widely used in mainstream private securities offerings, significant attention to waivers of bad actor disqualifications emerged as the first waivers were granted under Rule 506 (such as those granted to Oppenheimer and H.D. Vest). The attention to the issue culminated in several SEC commissioners publicly expressing diverging views about the proper use of waivers, including in speeches by SEC Commissioners Daniel Gallagher, Kara Stein and Michael Piwowar and SEC Chair Mary Jo White. This ultimately led to the SEC issuing its recent policy statement to bring consistency to how such waivers are granted, whether under Regulation A, Rule 505 or Rule 506.

Summary of Factors Considered in Waiver Requests

To obtain a waiver, the applicant bears the burden of showing good cause that a waiver is justified. While no single factor is dispositive, the Division will consider whether the showing has been met by taking into account the nature of the violation or conviction. For example, a criminal conviction or “scienter”-based violation would entail a significantly greater burden than would a civil or administrative non-scienter violation (or, the policy statement implies, a violation that did not involve the offer and sale of securities). The focus of the analysis is how the misconduct bears on the applicant’s fitness to participate in private or limited offerings of securities in which investors will not receive the benefits of the full SEC registration.

Here is a quick summary of the factors described the policy statement (which is already rather short):

  • Who Was Responsible for the Misconduct? It would be a negative factor if the party seeking the waiver is the same as the party responsible for the misconduct or a control person who continues to exert influence on the operations of the entity seeking the waiver. It would also be a negative factor if the entity condoned, encouraged, did not address, or disregarded warning signs as to the misconduct, or obstructed regulators or law enforcement. It would be a favorable factor if the misconduct at issue was committed by one or more individuals and the applicant removes or terminates its association with them.
  • What Was the Duration of the Misconduct? Misconduct over an extended period would be a negative factor. An isolated instance would be a favorable factor.
  • What Remedial Steps Have Been Taken? This includes considering when the remedial measures were taken and their likelihood of preventing a recurrence of misconduct. Favorable factors could include a changes in the control of the applicant, departure of the personnel involved in the misconduct, improved training or improved policies, procedures or practices. Negative factors could include a history of similar misconduct that suggests future misconduct would be more likely.
  • Impact if the Waiver is Denied. This includes considering the severity of the impact on the issuer or third parties, such as investors, clients or customers, if the waiver is not granted in light of historical or planned use of the exemption, relative to the parties involved and the nature of the misconduct. A disproportionate hardship would be a favorable factor, and a minor impact would be a negative factor.

Waivers may be subject to conditions or limitations, and the policy statement indicates that waiver recipients may be asked to provide disclosure about the disqualifying event to investors a reasonable time prior to sales occurring in future exempt offerings.