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Statement on WKSI Waivers

Commissioner Daniel M. Gallagher

April 29, 2014

In 2005, the Commission adopted a package of new rules referred to as “Securities Offering Reform”—an all-too-rare example of the Commission taking a major action of its own volition to facilitate capital formation.  The release created a new category of issuer—the Well-Known Seasoned Issuer, or WKSI—and granted to WKSIs enhanced flexibility in accessing the capital markets.  WKSIs are defined to include the largest, most widely-followed issuers.  But certain issuers that would otherwise be WKSIs are excluded as “ineligible” under certain conditions (e.g., a criminal conviction).  The Commission can waive ineligible issuer status if it determines that it is not necessary under the circumstances that an issuer be considered ineligible.  This authority to grant WKSI waivers has been delegated to the Division of Corporation Finance.

The Division of Corporation Finance has set forth, in its Revised Statement on Well-Known Seasoned Issuer Waivers (Apr. 24, 2014) (“WKSI Statement”), a framework for assessing the merits of WKSI waiver applications.  I believe this framework is generally well-reasoned, but that certain aspects of it deserve extra attention.

Under the WKSI Statement, the touchstone of the analysis is the reliability of the issuer’s current and future disclosure.[1]  If the misconduct that triggered the disqualification does not affect the issuer’s current and future disclosure—or, if it did affect the issuer’s disclosure but, because of the issuer’s remediation, such disclosure will be reliable going forward—then granting the WKSI waiver is appropriate.

But this view exists in tension with a different perspective:  that WKSI status is a privilege, and disqualification for bad actions is an appropriate punishment for those actions.  This opposing view is reflected in language in the WKSI Statement placing a greater burden on an issuer to show why disqualification for a criminal or scienter-based civil sanction would not be appropriate.[2]  Procedurally, this approach is difficult to apply, because the type of sanction imposed does not actually indicate anything about the reliability of the issuer’s financial reporting.  Should a criminal conviction under the Migratory Bird Treaty Act for a wind farm’s killing of protected birds be weighed more heavily than a civil, non-scienter books and records violation, even though the former has nothing to do with financial reporting and the latter does?  Should our assessment be driven by the whims of a jury, or a prosecutor out to score political points?  Or should it, as I believe, be driven by a careful analysis of the facts underlying the misconduct and whether they negatively impact the issuer’s ability to produce accurate and reliable financial information?

Philosophically, the punishment-focused view of WKSI waivers is even more troubling.  I am not proposing to ignore the severity or gravity of criminal misconduct.  These types of violations are serious, and should be treated as such.  But the misconduct itself is appropriately punished through the underlying criminal or civil enforcement process.  It is only when that process has been exhausted, and the entity appropriately punished, that we turn to the question of whether the collateral consequence of that punishment—the loss of WKSI status—should be waived.  The question of whether to grant a WKSI waiver is, or at least used to be, a dispassionate analysis, undertaken by the technical experts in the Division of Corporation Finance, separate and apart from the enforcement process.

Finally, this punishment-based view is also constitutionally dubious.  The basic tenets of due process require that respondents have notice and the ability to be heard.  There is already a troubling trend toward increased automatic disqualification in the securities laws:  for example, the recent Bad Actor disqualifications in Rule 506 of Regulation D, and the proposed amendment to Regulation D that would disqualify issuers from subsequent Rule 506(c) offerings if they miss a filing deadline.  If we are to view WKSI disqualification as punitive in nature, then we should amend our rules to treat WKSI disqualification as we do officer and director, penny stock, and industry bars:  there should be an administrative proceeding, including notice and an opportunity to be heard, before affirmative Commission action to revoke WKSI status, if needed, is taken.

Moreover, it is important to ask who is really punished by the loss of WKSI status.  Rather than targeting the individuals who engaged in the wrongful conduct, loss of WKSI status punishes the issuer by removing important flexibility that the issuer has in the issuance of securities.  That harm in and of itself redounds to the detriment of the issuer’s shareholders.  In addition, recent research indicates that WKSI issuers provide better information to the market.[3]  Stripping a company of WKSI status could make shareholders less informed, compounding the harm to investors and impeding price discovery and capital formation to the detriment of the broader market.

I therefore believe that the Commission should approach each request for a WKSI waiver mindful of the fact that our disqualification provisions are prophylactic, and therefore over-inclusive in nature.  We must have a robust waiver program to appropriately distinguish between cases when disqualification is and is not justified.  Disqualification is justified—and the WKSI waiver should not be granted—in circumstances where the issuer’s financial reporting cannot be trusted.  It is only then that investors would benefit more from forcing the issuer to jump through additional hoops of Commission review than they would be harmed from the issuer’s loss of WKSI status.  Refusing to grant a waiver is not a step that we should take lightly.

[1] “The Division’s assessment in determining whether an issuer has shown good cause that ineligible issuer status is not necessary for the public interest or the protection of investors focuses on how the conduct that gave rise to the ineligibility relates to the reliability of the issuer’s current and future disclosure and, if it does, what steps the issuer has taken to remediate any deficiencies.”  WKSI Statement.

[2] “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.”  Id.

[3] See Sarah Clinton, Joshua White & Tracie Woidtke, Differences in the Information Environment Prior to Seasoned Equity Offerings under Relaxed Disclosure Regulation, DERA Working Paper 2013-03 (Jan. 23, 2014), available at (stating, in the Abstract:  “We find more frequent disclosure of management earnings forecasts and Form 8-K filings during the month before an SEO [seasoned equity offering] under SOR [securities offering reform].  Earnings forecasts also are more accurate and 8-K filings contain more information during this time.  In addition, we find a greater magnitude of information reflected in stock prices and more positive net returns under SOR concentrated in SEOs preceded by disclosure within a week before the issue date.  Moreover, there is no reversal in returns after the issue date.  Overall, these results suggest that SOR is associated with greater disclosure when investors commit to invest and assess the SEO price, which is related to a richer information environment with capital formation benefits.”).

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