Category: Corporate Governance
SEC charges Becton Dickinson with misleading investors about regulatory risks and product sales
The SEC has announced settled charges against Becton, Dickinson and Company, a medical device manufacturer known as BD listed on the NYSE, for “repeatedly misleading investors about risks associated with its continued sales of its Alaris infusion pump and for overstating its income by failing to record the costs of fixing multiple software flaws with the pump.” In essence, the company failed to disclose that it needed, but did not have, FDA clearance for certain changes to the software for its Alaris product, sales of which contributed about 10% of BD’s profits. Without those changes, the product was potentially harmful to patients. “Rather than inform investors that these issues heightened the risk that the FDA would limit BD’s ability to continue selling Alaris,” the SEC charged, “BD made misleading statements in its periodic reports about its regulatory risks.” BD agreed to pay a $175 million civil penalty. Companies in the life sciences should take note that this is yet another recent Enforcement action aimed at a life science company’s alleged misleading statements, including hypothetical or generic risks, regarding regulatory (FDA) status; in charges announced earlier this month against Kiromic BioPharma, the SEC alleged that Kiromic had failed to disclose that the FDA had placed both of its INDs on clinical hold. (See this PubCo post.) According to Sanjay Wadhwa, Acting Director of SEC Enforcement, “BD repeatedly painted a misleading picture of its Alaris infusion pump for investors and then doubled down by keeping them in the dark when the device’s issues came to a head with the FDA in late 2019….Public companies have a fundamental duty to accurately disclose material business risks and should expect to be held accountable when they fall short in that regard.”
Happy Holidays!
SEC Enforcement charges Express for failure to disclose CEO perks
The SEC has announced settled charges against Express, Inc., a multi-brand American fashion retailer formerly listed on the NYSE, for failing to disclose over a three-year period almost $1 million in perks provided to its now former CEO. What were those perks? About a half of that amount was attributable to the perk that seems to trip up so many companies (and flashing favorite target of SEC Enforcement): use of company-owned or -leased aircraft and other travel expenses for personal purposes. The SEC also charged that the company “did not have adequate controls, policies, or procedures in place to effectively identify and analyze potential compensation for disclosure.” However, the SEC did not impose civil penalties on the company, which filed for bankruptcy, in light of its cooperation. According to Sanjay Wadhwa, the Acting Director of Enforcement, “[p]ublic companies have a duty to comply with their disclosure obligations regarding executive compensation, including perks and personal benefits, so that investors can make educated investment decisions….Here, although Express fell short in carrying out its obligation, the Commission declined to impose a civil penalty based, in part, on the company’s self-report, cooperation with the staff’s investigation, and remedial efforts.”
UPDATED—en banc Fifth Circuit puts the kibosh on the Nasdaq board diversity rules
(This post updates my post of December 12 to add further discussion of the decision.)
In August 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules adopted a “comply or explain” mandate for board diversity for most listed companies and required companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. (See this PubCo post.) It didn’t take long for a court challenge to these rules to materialize: the Alliance for Fair Board Recruitment and, later, the National Center for Public Policy Research petitioned the Fifth Circuit Court of Appeals—the Alliance has its principal place of business in Texas—for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post and this PubCo post.) (Reuters points out that the same pair of challengers “led the successful U.S. Supreme Court challenge against race-conscious college admissions policies.” In October 2023, a three-judge panel of the Fifth Circuit denied those petitions, in effect upholding Nasdaq’s board diversity listing rules. Given that, by repute, the Fifth Circuit is the circuit of choice for advocates of conservative causes, the decision to deny the petition may have taken some by surprise—unless, that is, they were aware, as discussed in the WSJ and Reuters, that the three judges on that panel happened to all be appointed by Democrats. Petitioners then filed a petition requesting a rehearing en banc by the Fifth Circuit, where Republican presidents have appointed 12 of the 16 active judges. (See this PubCo post.) Not that politics has anything to do with it, of course. That petition for rehearing en banc was granted, vacating the opinion of the lower court. In May, the en banc court heard oral argument, with a discussion dominated by rule skeptics. (See this PubCo post.) Last week, the Fifth Circuit, sitting en banc, issued its opinion in Alliance for Fair Board Recruitment v. SEC, vacating the SEC’s order approving Nasdaq’s board diversity proposal. No surprise there—the surprise was that the vote by the Fifth Circuit was nine to eight. The majority of the Court applied a strict interpretation—some might call it pinched—of the purposes of the Exchange Act to hold that the Nasdaq board diversity rules “cannot be squared with the Securities Exchange Act of 1934,” and, therefore, the SEC had no business approving them. Ironically, the dissent also contended that the SEC’s authority was limited—that its statutory authority to disapprove a rule proposed by Nasdaq, cast by the dissent as a “private entity” engaged in private ordering, was constrained by the Exchange Act. In effect, the dissent contended, the majority was advocating that the agency intrude more on this exercise in private ordering. According to Bloomberg Law, a “Nasdaq representative said the exchange disagreed with the court’s decision, but doesn’t plan to appeal the ruling. An SEC spokesperson said the agency is ‘reviewing the decision and will determine next steps as appropriate.’” But if Nasdaq doesn’t appeal, how likely is it that the new Administration would do so?
En banc Fifth Circuit puts the kibosh on the Nasdaq board diversity rules
In August 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. The new listing rules adopted a “comply or explain” mandate for board diversity for most listed companies and required companies listed on Nasdaq’s U.S. exchange to publicly disclose “consistent, transparent diversity statistics” regarding the composition of their boards. (See this PubCo post.) It didn’t take long for a court challenge to these rules to materialize: the Alliance for Fair Board Recruitment and, later, the National Center for Public Policy Research petitioned the Fifth Circuit Court of Appeals—the Alliance has its principal place of business in Texas—for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post and this PubCo post) In October 2023, a three-judge panel of the Fifth Circuit denied those petitions, in effect upholding Nasdaq’s board diversity listing rules. Given that, by repute, the Fifth Circuit is the circuit of choice for advocates of conservative causes, the decision to deny the petition may have taken some by surprise—unless, that is, they were aware, as discussed in the WSJ and Reuters, that the three judges on this panel happened to all be appointed by Democrats. Petitioners then filed a petition requesting a rehearing en banc by the Fifth Circuit, where Republican presidents have appointed 12 of the 16 active judges. (See this PubCo post.) Not that politics has anything to do with it, of course. That petition for rehearing en banc was granted, vacating the opinion of the lower court. In May, the en banc court heard oral argument, with a discussion was dominated by rule skeptics. (See this PubCo post.) Yesterday, the Court issued its opinion in Alliance for Fair Board Recruitment v. SEC. No surprise there—the majority of the Court held that the Nasdaq diversity rules “cannot be squared with the Securities Exchange Act of 1934.” The surprise was that the vote on the Fifth Circuit was nine to eight. According to Bloomberg Law, a “Nasdaq representative said the exchange disagreed with the court’s decision, but doesn’t plan to appeal the ruling. An SEC spokesperson said the agency is ‘reviewing the decision and will determine next steps as appropriate.’” But if Nasdaq doesn’t appeal, how likely is that the new Administration would do so?
Below is a very quick paragraph to alert you to the decision. I plan to write a much longer post on the case (including the dissent) in the next day or so. Stay tuned for the update.
How should the board consider security concerns for executives?
After the alarming murder of an insurance company CEO last week, questions about protection and security for CEOs and other executives are suddenly high on the agenda for boards of directors. A big concern: will there be copycat attempts? According to a security officer for a threat management software company, quoted on CNBC.com, “Everyone’s scrambling to say, ‘Are we safe?’….This is an inflection point where the idea of executive protection is now raised to the board level. Everyone I know in the industry is feeling this.” This anxiety is only compounded by the volume of information available online disclosing executives’ addresses and itineraries. As discussed in this new article from the Harvard Business Review, while incidents of workplace violence are “unfortunately too common” in the U.S., CEO targeting is “relatively rare.” But that risk level may have changed: in “today’s world of grievance and anger, easy access to weapons and information, and high-profile attacks on public figures, companies must take seriously their duty of care for executives and employees alike.” The article presents a framework for C-suites and boards “to balance competing interests of need, efficacy, and cost to ensure executive protection….How does a company strike the right approach in preventing the low likelihood, but very high consequence of an attack on a CEO?”
CEO succession: Is it a good idea to appoint a board member to be CEO?
In this article from the Harvard Business Review, the authors, from global leadership advisory firm ghSMART, discuss the growing number of instances in which companies appoint CEOs from the board. According to the article, from 2018 to 2023, 10% (213) of the total number of new CEOs in the S&P 500 and Russell 3000 were appointments from the board, reflecting a threefold increase over the period, and “making board director the fourth-most-common pre-CEO role,” after various executive roles. The authors note that the majority of those 213 CEOs were permanent hires. Interestingly, however, the authors observe that when a company appoints one of its own board members as CEO, the frequent assumption is that there must have been a problem with succession planning: “Maybe the company is desperately trying to get itself out of a protracted period of tumult. Maybe the previous CEO’s departure was unexpected or forced, and only a tried-and-true board member can keep the ship sailing steadily until a permanent replacement can be found. Maybe the CEO’s departure was routine and expected, but somehow the succession-planning process just came up short.” But sometimes, they suggest, the reality is that the board member was actually “the best option” to serve in that role. Why might it be a good idea? What can go wrong? How can the company increase its chances of success? In their article, the authors address these questions.
SEC charges biopharma with misleading investors about status of INDs
The SEC has announced that it filed settled charges against Kiromic BioPharma and two of its executives for alleged failure to disclose in its public statements and filings, including in its public offering prospectus, material information about its investigational new drug applications filed with the FDA for two of its drug candidates—the only two product candidates in the company’s pipeline. What was that omitted information? That the FDA had placed both of its INDs on clinical hold, meaning that the proposed clinical investigations could not proceed until the company first corrected the deficiencies cited by the FDA. Instead of disclosing in its prospectus that the INDs had actually been placed on clinical hold, the company included a risk factor describing the “hypothetical risk of a clinical hold and the potential negative consequences” on the company’s business. In light of the company’s voluntary self-reporting, remediation and other proactive cooperation, there was no civil penalty for the company, but two executives, the then-CEO and then-CFO, agreed to pay civil penalties of $125,000 and $20,000. According to the Director of the SEC’s Fort Worth Regional Office, the resolution of these cases strikes “the right balance between holding Kiromic’s then-two most senior officers responsible for Kiromic’s disclosure failures while also crediting Kiromic for its voluntary self-report, remediation, proactively instituting remedial measures, and providing meaningful cooperation to the staff.”
SEC charges UPS with failure to take goodwill impairment charge require by GAAP
Last week, the SEC announced settled charges against United Parcel Service Inc. for failing to take an appropriate goodwill impairment charge for a poorly performing business unit, thus materially misrepresenting its earnings. As alleged by the SEC, instead of calculating the write-down based on the price UPS expected to receive to sell its Freight business unit—as required under GAAP—UPS relied on a valuation prepared by an outside consultant, but “without giving the consultant information necessary to conduct a fair valuation of the business.” According to the Associate Director of Enforcement, “[g]oodwill balances provide investors with valuable insight into whether companies are successfully operating the businesses they own….Therefore, it is essential for companies to prepare reliable fair value estimates and impair goodwill when required. UPS fell short of these obligations, repeatedly ignoring its own well-founded sale price estimates for Freight in favor of unreliable third-party valuations.” UPS was charged with making material representations in its reporting, as well as violations of the book and records, internal accounting controls, and disclosure controls provisions of the Exchange Act and related rules. UPS agreed to adopt training requirements for certain officers, directors and employees, retain an independent compliance consultant and pay a $45 million civil penalty.
Happy Thanksgiving!
Just in time for Thanksgiving, SEC charges Elanco with undisclosed stuffing—channel stuffing, that is
In this settled action, In the Matter of Elanco Animal Health, Inc., Elanco, a manufacturer and seller of animal health products, such as flea and tick medications, was charged with “failure to disclose material information concerning its sales practices that rendered statements it made about its revenue growth misleading.” As alleged by the SEC, “Elanco would entice distributors to make end-of-quarter purchases in excess of then-existing customer demand by offering them incentives such as rebates and extended payment terms. These incentives allowed Elanco to improve its revenue each quarter, but caused distributors to purchase products ahead of end-user demand. Without these Incentivized Sales, Elanco would have missed its internal revenue and core growth targets in each quarter in 2019.” Essentially, we’re talking here about channel stuffing. As the practice continued, it contributed over the period to “channel inventory increasing by over $100 million in gross value…during 2019, creating a build-up of excess inventory at distributors and a reasonably likely risk of a decrease in revenue and revenue growth in future periods. But, for each quarter during the Relevant Period, Elanco failed to disclose the significant impact of its Quarter-End Incentivized Sales and the reasonably likely risk that these sales practices could have a negative impact on revenue in future quarters.” The SEC charged that these disclosure failures rendered the positive statements that Elanco made about revenue materially misleading. And let’s not forget the disclosure controls violations. In settling the action, Elanco agreed to pay a civil money penalty of $15 million.
PLI panel offers hot tips on accounting and auditing issues
At the PLI Securities Regulation Institute last week, the accounting and auditing update panel provided some useful insights—especially for non-accountants. The panel covered the new requirements for segment reporting, the intensified focus on controls, PCAOB activities (including NOCLAR) and errors and materiality. Below are some takeaways.
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