Category: Litigation
SEC charges “AI-washing” at Presto Automation
Is “-washing” the securities fraud equivalent of “-gate” for political scandals? First we had greenwashing, then diversity-washing, and now we have AI-washing—a topic that, as discussed in the SideBar below, SEC officials made a lot of noise about last year. And this recent action by the SEC certainly seems to allege just that—even though the SEC doesn’t actually use the term. In mid-January, the SEC announced “settled charges against Presto Automation Inc., a restaurant-technology company that was listed on the Nasdaq until September 2024, for making materially false and misleading statements about critical aspects of its flagship artificial intelligence (AI) product, Presto Voice. Presto Voice employs AI-assisted speech recognition technology to automate aspects of drive-thru order taking at quick-service restaurants.” However, as alleged in the Order, the AI technology used in the product was not developed by Presto—at least not until September 2022; rather, the company deployed speech recognition technology owned and operated by a third party. But, the SEC charged, Presto failed to disclose in its SEC filings that it used the third party’s AI technology, rather than its own, to power all of the Presto Voice units it deployed commercially during that time period. What’s more, once Presto did begin to use its own proprietary technology in the Presto Voice units, the SEC alleged, the company “misrepresented the capabilities of the product by claiming that it eliminated the need for human order taking.” Not the case, the SEC alleged; “substantial human involvement” was actually required. The SEC charged that Presto made materially misleading statements in violation of the Securities and Exchange Acts and failed to maintain adequate disclosure controls; however, in light of its financial condition and remedial actions, the SEC imposed only a cease-and-desist order and no civil money penalty.
Commissioner Peirce offers her prescription for a “path back to normal”
This week, SEC Commissioner Hester Peirce delivered the keynote address at the Northwestern Securities Regulation Institute in San Diego. Her theme: that public companies are “confronting a symptom of a larger societal malady—importing politics and contentious social issues into everything we do.” According to Peirce, the “SEC, so-called stakeholders, and the burgeoning industry of advisers, consultants, accountants, and attorneys peddling their costly wares to public companies, sometimes with the agreement of corporate executives, drag companies into social and political melees. Their efforts, an insidious form of rent-seeking, are often quite convincingly disguised in a cloak of ethics and morality.” In her remarks, she proposed seven steps toward regaining what, in her view, was the “path back to normal.” A harbinger of what is to come in the next four years?
In case there was any doubt, SEC approves Nasdaq proposal to remove Board diversity rules
In August 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure. 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.) A court challenge to these rules quickly materialized: the Alliance for Fair Board Recruitment and, later, the National Center for Public Policy Research petitioned the Fifth Circuit Court of Appeals for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post and this PubCo post.) In December last year, the en banc Fifth Circuit issued its opinion in Alliance for Fair Board Recruitment v. SEC vacating the SEC’s order approving Nasdaq’s board diversity proposal by a vote of nine to eight. According to an article in Bloomberg Law, following the decision, 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.’” (That, of course, was prior to the last election.) That question is now moot: Nasdaq filed a proposal with the SEC seeking to remove from the Nasdaq rules the relevant board diversity provisions to reflect “a Federal court’s vacatur of the Commission’s order of August 6, 2021, approving rules related to Board diversity disclosures. Nasdaq has requested that the Commission waive the operative delay to allow the proposed rule change to become effective on February 4, 2025.” And, this past Friday, the SEC declared the proposal to be immediately effective. Just in case anyone was unsure about the status of the board diversity rules, the effect of the proposal will be to “clarify Nasdaq’s rules by aligning them with the court’s decision.”
SEC charges Celsius Holdings with improper accounting for stock awards and disclosure control failures
In this settled action—part of a slew of SEC Enforcement cases reported out in the last days before the change in Administration—the SEC alleged that Celsius Holdings, Inc. engaged in improper accounting for stock-based compensation expenses when the company modified the terms of stock awards for six departing employees and retiring board members, but failed to re-value them as required under GAAP. As a result, the SEC alleged, in periodic and current reports, Celsius’ financial statements were materially inaccurate and misleading. The SEC charged that Celsius violated the reporting, books and records, internal accounting controls and disclosure controls and procedures provisions. Celsius has agreed to pay $3 million to settle the charges.
SEC files complaint against Elon Musk alleging violation of Section 13(d)
On Tuesday, the SEC filed a complaint in the D.C. federal district court alleging that Elon Musk ignored the Section 13(d) beneficial ownership reporting deadline when, in March 2022, he acquired more than 5% of outstanding Twitter shares. Because Musk failed to timely file the report with the SEC, the SEC alleged, he was able to continue to make purchases of Twitter common stock at artificially low prices, allowing him to underpay for the shares by at least $150 million Hmmm. Think this case will be pursued after the SEC comes under new management?
McMahon takes a bump
On Friday, the SEC announced settled charges against Vince McMahon, founder, controlling shareholder and former Executive Chair and CEO of World Wrestling Entertainment, for “knowingly circumventing WWE’s internal accounting controls,” making false or misleading statements to WWE’s auditor, and causing “WWE’s violations of the reporting and books and records provisions of the Exchange Act.” The SEC alleged that McMahon signed two settlement agreements relating to claims of sexual misconduct (as the WSJ framed it), one in 2019 and one in 2022, on behalf of himself and WWE but failed to disclose the existence of the agreements to “WWE’s Board of Directors, legal department, accountants, financial reporting personnel, or auditor.” Oops. The SEC charged that this omission “circumvented WWE’s system of internal accounting controls and caused material misstatements in WWE’s 2018 and 2021 financial statements,” leading WWE ultimately to issue financial restatements. McMahon agreed to pay a $400,000 civil penalty and to reimburse WWE just over $1.3 million pursuant to SOX 304(a), the SOX clawback provision. According to the Associate Regional Director in the SEC’s New York Regional Office, “[c]ompany executives cannot enter into material agreements on behalf of the company they serve and withhold that information from the company’s control functions and auditor.” (Even if—or maybe especially if—it involves hush money.)
SEC charges Entergy with violation of internal accounting controls requirements
At the end of last year, the SEC announced settled charges against Entergy Corporation, a Louisiana-based utility company with shares traded on the NYSE, for failure to maintain internal accounting controls adequate to ensure that its surplus materials and supplies were accurately recorded on its books and financial statements in accordance with GAAP. The case represents yet another example where the charged misconduct related only to ineffective controls, without any associated charges of fraud. According to Sanjay Wadhwa, Acting SEC Enforcement Director, “internal accounting controls serve as a front-line defense in ensuring the accuracy and reliability of financial statements….Investors rely on public companies, such as Entergy, to ensure that adequate internal accounting controls are in place. We allege that Entergy failed to fulfill its obligation in this regard.” Entergy agreed to pay a civil penalty of $12 million. Rumor has it that we’re likely not going to see a lot more of these “controls-only” types of Enforcement actions once the SEC comes under new management.
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.”
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