On March 12, 2014, the SEC updated its guidance regarding the framework it will follow in reviewing a “WKSI waiver” request. Such a waiver – which, if granted, allows an issuer to continue to qualify as a WKSI despite otherwise disqualifying misconduct – is critical to the affected issuer’s ability to access the capital markets. These waivers have become particularly important for bank and other financial holding companies with large networks of subsidiaries, one or more of which may have been charged with mortgage securities fraud or other crimes arising out of the recent financial crisis. Under the revised guidance, the SEC will consider many of the same factors in a waiver request as before, but will no longer highlight certain aspects of the underlying offense as threshold issues, as under the prior guidance. As a result, issuers will need to take greater care in their waiver requests to address all of the various considerations raised by the SEC in its guidance and apply them to the issuer’s particular facts and circumstances.
WKSI Waivers
Well-known seasoned issuers, or WKSIs, are a category of issuers consisting of the largest, most actively traded and widely followed public companies. WKSIs are afforded maximum flexibility under U.S. securities laws, including, most notably, the ability to file automatically effective shelf registration statements. As a result, a WKSI is able to conduct registered offerings of debt and equity securities without the delay associated with SEC review. A company that would otherwise qualify as a WKSI can lose this preferred status, however, if it or one of its subsidiaries violates the anti-fraud provisions of the federal securities laws, thereby becoming an “ineligible issuer.” Rule 405 under the Securities Act permits such an issuer to request a waiver of its ineligible issuer status “upon a showing of good cause, that it is not necessary under the circumstances that the issuer be considered an ineligible issuer.”
Revised Guidance
The SEC’s primary focus in considering a WKSI waiver request is whether the conduct giving rise to the ineligibility indicates that the issuer’s current and future disclosure may be unreliable, in which case permitting the issuer to file automatically effective registration statements (without SEC review) would be inappropriate. The SEC will examine whether the misconduct (i) related to the disclosures of the issuer or its subsidiaries or otherwise calls into question the ability of the issuer to produce reliable disclosures going forward and (ii) was criminal or scienter-based. The SEC will also consider the additional factors set forth below, none of which will be individually dispositive in its review:
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Responsibility for, and Duration of, the Misconduct. The SEC will focus on whether the misconduct was perpetrated by officers, directors or employees of the WKSI parent itself or by personnel of a subsidiary. Greater isolation between the misconduct and the persons responsible for the accuracy of the WKSI parent’s disclosures weighs in favor of granting the waiver. However, even if personnel of the WKSI parent are not directly implicated in the misconduct, the SEC will consider whether the WKSI’s officers or directors (i.e., those responsible for the reliability of the WKSI’s disclosures) knew or should have known of the misconduct, or created a corporate culture (a “tone at the top”) that condoned or ignored such behavior. Misconduct persisting over a period of time may indicate a lack of effective oversight at the WKSI parent level, which could be a predictor of unreliable future disclosures.
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Remedial Action. The SEC will consider whether the issuer has taken appropriate measures to address the violative conduct, and whether such measures would prevent a recurrence of the misconduct. Effective remedial action, which may include terminating personnel, training and improvements in internal controls and disclosure controls and procedures, may give the SEC comfort that, despite prior infractions, the issuer’s future disclosures will be reliable.
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Impact of Denial. The SEC will consider whether the loss of WKSI status would be a disproportionate hardship in light of the nature of the issuer’s misconduct. The SEC will consider whether denial of the waiver would impact the markets as a whole and the investing public, in light of the issuer’s significance and its connections to other market participants.
Comparison to Prior Guidance
The SEC’s prior guidance, issued in July 2011, considered many of the same factors, but in a more regimented fashion. Under the prior guidance, the SEC initially considered two threshold factors: first, whether the applicable violation stemmed from the issuer’s own disclosures about itself; and second, whether the violation was scienter-based. If the violation did not involve the issuer’s own disclosures, the SEC indicated a waiver would likely be granted, even if the offense was scienter-based. If the violation involved the issuer’s disclosures and was scienter-based, the SEC indicated the requested waiver would likely be denied. Finally, if the violation stemmed from the issuer’s own disclosures but was not scienter-based, the SEC would consider additional factors, namely (i) the remedial steps taken by the issuer, (ii) the pervasiveness and timing of the conduct and (iii) the impact that denial of the waiver would have on the issuer and the markets as a whole. Clearly the components of the SEC’s evaluation are similar under both the updated and prior guidance. Under the new approach, however, the SEC no longer considers, as threshold matters, whether the violation stemmed from the issuer’s disclosures or was scienter-based and, as a result, the additional considerations (e.g., remedial actions taken) will be analyzed in all cases.
Implications for the Preparation of WKSI Waiver Requests
Under the SEC’s prior guidance, a WKSI holding company could take relative comfort that it would be granted a WKSI waiver following misconduct by a subsidiary that did not impact the disclosures of the WKSI parent, even if the misconduct were scienter-based. In such cases, the issuer’s waiver request would often, in relatively perfunctory fashion, merely assert that the relevant misconduct did not affect the WKSI parent’s disclosures and cite the severe and disproportionate impact that would result from denial of the waiver (see, for example, here, here and here). Under the prior guidance, issuers would commonly only address the additional considerations (i.e., remedial steps, pervasiveness and timing) in cases involving non-scienter-based misconduct that affected the issuer’s own disclosures (see, for example, here, here and here). Through its revised guidance, the SEC appears to have rejected the former approach under which certain aspects of the underlying violation were analyzed as threshold issues, with the result of such analysis impacting the extent to which additional factors were considered. Therefore, issuers will need to be certain to craft comprehensive waiver requests that address all of the considerations raised by the SEC, regardless of the nature of the underlying misconduct.
