At the end of September, the SEC announced that it had filed a complaint in federal court charging pharma Mylan N.V. with failing to timely disclose in its financial statements the “reasonably possible” material losses arising out of a DOJ civil investigation. The DOJ had investigated whether, by misclassifying its biggest product, the EpiPen, as a “generic,” Mylan had overcharged Medicaid by hundreds of millions of dollars. According to the complaint, although the investigation continued for two years, Mylan also failed to accrue for the “probable and reasonably estimable” material losses, as required under GAAP, until the announcement of a $465 million settlement with DOJ. In addition, some of Mylan’s other allegedly misleading disclosure flowed from its omission to discuss the claims. The SEC alleged that Mylan’s risk factor was misleading because it framed the government’s misclassification claim as a hypothetical possibility, when, in fact, the claim had already been made. As a consequence of these failures, the SEC alleged, Mylan’s SEC filings were false and misleading in violation of the Securities Act and Exchange Act. Mylan agreed to pay $30 million to settle the SEC’s charges. While the SEC complaint makes the matter sound straightforward, in practice, deciding whether, when and what to disclose or accrue for a loss contingency can often be a challenging exercise.
Yesterday, the SEC announced settled fraud charges under Rule 10b-5 against Nissan, its former CEO Carlos Ghosn, and Gregory Kelly, a former director, related to the failure to disclose over $140 million to be paid to Ghosn in retirement. (Here is the SEC’s Order and the complaint against Ghosn and Kelly filed in the SDNY.) Of course, you may be aware that Ghosn and the former director have been arrested by Japanese authorities and are awaiting trial, so these SEC charges were probably not the biggest glitch in their career paths. Nevertheless, the SEC’s action does stand as a warning that the SEC remains on the lookout for efforts to hide or disguise compensation from required public disclosure, especially where CEO discretion regarding compensation is largely unconstrained.
In this Enforcement Order, the SEC described a “revenue management scheme” orchestrated by the respondent, Marvell Technology Group, and the imposition on Marvell of a $5.5 million penalty and cease-and-desist order—not because of the scheme itself, but rather because the company failed to publicly disclose the scheme in its MD&A or to discuss its likely impact on future performance. The Order demonstrates that, even if a scheme involving unusual sales practices may not amount to chargeable accounting fraud, failure to disclose its distortive effects can be misleading and result in violations of the Securities Act and Exchange Act.
Reg FD prohibits selective disclosure of material, nonpublic information by public companies (or by its senior officials or specified other employees) to securities market professionals and shareholders reasonably likely to trade on the information. If a public company does make a disclosure of that kind, the company is required under Reg FD to disclose the information to the public. Information is considered “material” if there is “a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or if the information would significantly alter the total mix of available information.” And that’s where the thorny part comes in. The test for materiality is a subjective one, based on the facts and circumstances. But judgments about materiality of disclosures are often complicated and muddy and frequently made in real time.
At the end of last week, the SEC voted, without an open meeting, to propose amendments to modernize the descriptions of business, legal proceedings and risk factors in Reg S-K. The proposal is another component of the SEC’s “Disclosure Effectiveness Initiative.” In crafting the proposal, the SEC took into account comments received on the 2016 Concept Release on disclosure simplification and modernization (see this PubCo post), as well as Corp Fin staff experience in review of disclosures. The changes to the rules were proposed “in light of the many changes that have occurred in our capital markets and the domestic and global economy in the more than 30 years since their adoption, including changes in the mix of businesses that participate in our public markets, changes in the way businesses operate, which may affect the relevance of current disclosure requirements, changes in technology (in particular the availability of information), and changes such as inflation that have occurred simply with the passage of time.” There is a 60-day comment period.
It was only a matter of time. As reported here on Bloomberg, a conservative activist group has filed a lawsuit, Crest v. Alex Padilla, in California state court on behalf of three California taxpayers seeking to prevent implementation and enforcement of SB 826, California’s Board gender diversity legislation. This appears to be the first litigation filed to challenge the new law. Framed as a “taxpayer suit,” the litigation seeks to enjoin Alex Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution.
No, it’s not an episode of Top Chef, but it is about “cooking the books.” And those are just some of the ingredients and tools used by Brixmor Property Group, a publicly traded REIT, and four of its executives to do the cooking: manipulation of a key non-GAAP financial measure, according to this SEC complaint and order and, even more to the point, this SDNY criminal indictment of the executives. As alleged, management sought to create the impression that a static pool of its existing properties showed steady and predictable income growth across a number of quarters. In contrast, however, Brixmor’s actual income growth rate was “volatile and frequently fell above or below the company’s publically issued guidance range” for the period. So, according to the order, the company architected the desired illusion—touted as its “secret sauce”—by engaging in some “sausage-making” with regular hits to the “cookie jar.” While it doesn’t sound very appetizing, it did create the desired deception—until, of course, it didn’t. The lesson is that manipulation of a non-GAAP measure, together with violations of GAAP, to mislead the public can be trouble—and perhaps even criminal. Although cases of accounting fraud may not be as common as they once were, this case should serve as a reminder that the SEC and the Justice Department are still on the lookout for it.