Category: Litigation
Workplace misconduct again! SEC charges failure of disclosure controls
Alleged workplace misconduct—and the obligation to collect information and report up about it—rears its head again in yet another case, this time involving Activision Blizzard, Inc. Just last month, in In re McDonald’s Corporation, the former “Chief People Officer” of McDonald’s Corporation was alleged to have breached his fiduciary duty of oversight by consciously ignoring red flags about sexual harassment and misconduct in the workplace. According to the court in that case, the defendant “had an obligation to make a good faith effort to put in place reasonable information systems so that he obtained the information necessary to do his job and report to the CEO and the board, and he could not consciously ignore red flags indicating that the corporation was going to suffer harm.” (See this PubCo post.) Now, the SEC has issued an Order in connection with a settled action alleging that Activision Blizzard, Inc., a videogame developer and publisher, violated the Exchange Act’s disclosure controls rule because it “lacked controls and procedures designed to ensure that information related to employee complaints of workplace misconduct would be communicated to Activision Blizzard’s disclosure personnel to allow for timely assessment on its disclosures.” In addition, the SEC alleged that the company violated the whistleblower protection rules by requiring, in separation agreements, that former employees “notify the company if they received a request from a government administrative agency in connection with a report or complaint.” As a result, Activision Blizzard agreed to pay a $35 million civil penalty. These cases suggest that company actions (or lack thereof) around workplace misconduct and information gathering and reporting about it have resonance far beyond employment law. It’s also noteworthy that this Order represents yet another case (see this PubCo post) where a “control failure” is a lever used by SEC Enforcement to bring charges against a company notwithstanding the absence of any specific allegations of material misrepresentation or misleading disclosure, a point underscored by Commissioner Hester Peirce in her dissenting statement, discussed below.
Delaware VC Laster finds a “black swan”—a fiduciary duty of oversight for officers
In In re McDonald’s Corporation, defendant David Fairhurst, who formerly served as Executive Vice President and Global Chief People Officer of McDonald’s Corporation, contested a stockholders’ claim that he had breached his fiduciary duty of oversight by arguing that there is no fiduciary duty of oversight for officers, only for directors. VC Laster of the Delaware Chancery Court responded this way: “That observation is descriptively accurate, but it does not follow that officers do not owe oversight duties. For centuries dating back to the Roman satirist Juvenal, Europeans used the phrase ‘black swan’ as a figure of speech for something that did not exist. Then in the late eighteen century, Europeans arrived on the shores of Australia, where they found black swans. The fact that no one had seen one before did not mean that they could not or did not exist…. Framed in terms of the issue in this case, decisions recognizing director oversight duties confirm that directors owe those duties; those decisions do not rule out the possibility that officers also owe oversight duties.” With that—and a lengthy exposition—Laster confirmed that Fairhurst did indeed have a duty of oversight, much like the Caremark duties applicable to corporate directors.
Audit committee oversight of ESG fraud risk
In this article, accounting firm Deloitte observes that boards and managements often experience “denial” when the topic of fraud risk arises—no one wants to feel that the trust they place in their own employees is actually misplaced. Still, fraud risk is one topic that typically finds its way onto the agendas of audit committees. Deloitte advises that, with the current attention to ESG and in anticipation of new rulemaking from the SEC on disclosure related to climate, human capital and other ESG-related topics (see this PubCo post), “fraud risk in this area should be top of mind for audit committees and a focal point in fraud risk assessments overseen by the audit committee.” While audit committees focus primarily on financial statement fraud risk, Deloitte suggests that audit committees should consider expanding their attention to fraud risk related to ESG, an area that is “not governed by the same types of controls present in financial reporting processes,” and, therefore, may be more susceptible to manipulation. In their oversight capacity, audit committees have a role to play, Deloitte suggests, by engaging with “management, including internal audit, fraud risk specialists, and independent auditors to understand the extent to which fraud risk is being considered and mitigated.”
SEC settles charges with McDonald’s and former CEO over deficient disclosures; two commissioners dissent
Inappropriate relationships with employees have landed a number of CEOs and other executives in hot water in the last few years, especially as the MeToo movement gained momentum. But these aren’t necessarily just employment issues, nor are they always limited to problems for the perpetrator. The SEC has just announced settled charges against McDonald’s and its former CEO, Stephen Easterbrook, arising out of the termination of Easterbrook “for exercising poor judgment and engaging in an inappropriate personal relationship with a McDonald’s employee in violation of company policy.” The SEC alleged that Easterbrook made “false and misleading statements to investors about the circumstances leading to his termination in November 2019.” But how was McDonald’s alleged to have violated the securities laws? The SEC charged that McDonald’s disclosures related to Easterbrook’s separation agreement were deficient in failing to disclose that the company “exercised discretion in terminating Easterbrook ‘without cause,’” allowing Easterbrook to “retain substantial equity compensation.” The SEC’s Director of Enforcement asserted that, “[w]hen corporate officers corrupt internal processes to manage their personal reputations or line their own pockets, they breach their fundamental duties to shareholders, who are entitled to transparency and fair dealing from executives….By allegedly concealing the extent of his misconduct during the company’s internal investigation, Easterbrook broke that trust with—and ultimately misled—shareholders.” According to the Associate Director of Enforcement, “[p]ublic issuers, like McDonalds’s, are required to disclose and explain all material elements of their CEO’s compensation, including factors regarding any separation agreements….Today’s order finds that McDonald’s failed to disclose that the company exercised discretion in treating Easterbrook’s termination as without cause in conjunction with the execution of a separation agreement valued at more than $40 million.” As reported by the WSJ, “[i]n a statement Monday, McDonald’s said, ‘The SEC’s order reinforces what we have previously said: McDonald’s held Steve Easterbrook accountable for his misconduct. We fired him, and then sued him upon learning that he lied about his behavior.’” Commissioners Hester Peirce and Mark Uyeda dissented from the Order, contending that the SEC’s interpretation of the disclosure rule was beyond the rule’s scope.
Texas court jettisons NAM challenge to SEC’s proxy advisor rules
Is it ok for an agency to change its mind? The Federal District Court for the Western District of Texas seems to think so—at least if the agency’s decision is “reasonable and reasonably explained.” So says this Order granting summary judgment to the SEC and Chair Gary Gensler and denying summary judgment to the National Association of Manufacturers and the Natural Gas Services Group in the litigation surrounding the SEC’s adoption in 2022 of amendments to the rules regarding proxy advisory firms, such as ISS and Glass Lewis. Those 2022 rules reversed some of the key controversial provisions governing proxy voting advice that were adopted by the SEC in July 2020 and favored by NAM. In July of this year, NAM filed a complaint asking that the 2022 rules be set aside under the Administrative Procedure Act and declared unlawful and void, and, in September, NAM filed its motion for summary judgment, characterizing the case as “a study in capricious agency action.” The Court begged to differ. But, no surprise, we haven’t heard the last of this matter—NAM has already filed its notice of appeal.
AT&T settles Reg FD charges for record penalty
Yesterday, the SEC announced that it had settled charges against AT&T for alleged violations of Reg FD for $6.25 million, an amount that it characterized as a “record penalty”—the “largest ever in a Reg FD case.” The case involved allegations of one-on-one disclosures by three company executives of AT&T’s “projected and actual financial results” to a number of Wall Street research analysts in violation of Reg FD and Exchange Act 13(a). (See this PubCo post.) The three executives agreed to pay $25,000 each to settle charges. After the federal district court for the SDNY denied summary judgment for both sides in September (see this PubCo post), the case appeared to be on its way to trial, but that was headed off by this new settlement. According to Gurbir Grewal, Director of Enforcement, the “actions allegedly taken by AT&T executives to avoid falling short of analysts’ projections are precisely the type of conduct Regulation FD was designed to prevent….Compliance with Regulation FD ensures that issuers publicly disclose material information to the entire market and not just to select analysts.”
California Appeals Court reinstates injunctions against California Board diversity laws
You may recall that, earlier this year, two Los Angeles Superior Courts struck down as unconstitutional two California laws mandating that boards of public companies achieve specified levels of board diversity and enjoined implementation and enforcement of the legislation. Those injunctions, however, were temporarily lifted as the state appealed. Now, the appeals court has vacated those temporary stays. What does it mean for the diversity legislation?
SEC and DOJ conducting Rule 10b5-1 probe
As the SEC mulls its 10b5-1 proposal (see this PubCo post), neither its Enforcement Division nor the DOJ are waiting around to see what happens. According to Bloomberg, they are using data analytics “in a sweeping examination of preplanned equity sales by C-suite officials.” The question is whether executives “been gaming prearranged stock-sale programs designed to thwart the possibility of insider trading”? Of course, there have been countless studies and “exposés” of alleged 10b5-1 abuse over the years, the most recent being this front-page analysis of trading by insiders under Rule 10b5-1 plans in the WSJ (see this PubCo post). While these concerns have been percolating for quite some time, no legislation or rules have yet been adopted (although several bills have been introduced and the SEC proposed new regs at the end of 2021). Bloomberg reports that these investigations by Enforcement and the DOJ are consistent with the recent “tougher line on long-standing Wall Street trading practices during the Biden era. Federal officials requested information from executives early this year, said one person. They’re now preparing to bring multiple cases, said two other people.”
SEC reports Enforcement stats—the “risk-reward calculation is not what it was”
The SEC has announced its fiscal 2022 Enforcement stats, which hit new records. According to the press release, during the year, the SEC filed 760 total enforcement actions, representing a 9% increase over the prior year. That total included 462 new, or “stand-alone,” enforcement actions, which “ran the gamut of conduct, from ‘first-of-their-kind’ actions to cases charging traditional securities law violations.” The SEC also recovered a record $6.4 billion in civil penalties, disgorgement and pre-judgment interest in SEC actions, an increase of 68% from $3.8 billion in the prior year. Civil penalties, at $4.2 billion, were also the highest on record. The press release emphasized that the increase in penalties is intended to “deter future misconduct and enhance public accountability.” In a number of cases, the SEC “recalibrated penalties for certain violations, included prophylactic remedies, and required admissions where appropriate” to make “clear that the fines were not just a cost of doing business.” According to Director of Enforcement Gurbir Grewal, the SEC doesn’t “expect to break these records and set new ones each year because we expect behaviors to change. We expect compliance.” Interestingly, disgorgement, at $2.2 billion, declined 6% from last year. As reported by the WSJ, Grewal, speaking at a recent conference, highlighted the fact that the SEC imposed more penalties than disgorgements, which, in his view, “demonstrated that ‘the potential consequences of violating the law are significantly greater than the potential rewards.’… He added that the SEC ordered more than twice as much in disgorgements as it did in penalties for the five fiscal years before the last one. ‘So while disgorgement was slightly down from the prior year…it is the first time that the amount ordered to be paid in penalties has been double the amount ordered to be paid in disgorgement,’ he said. ‘The increased penalty-to-disgorgement ratio nonetheless demonstrates that the risk-reward calculation is not what it was even a few years ago.’”
Final climate rules are months away, reports Bloomberg
Here’s a big scoop from Bloomberg: the “SEC is months away from finalizing expansive new climate disclosure requirements as the agency juggles investor demands for more transparency, tech glitches and a tough Republican legal threat.” Are you really surprised though? That was a substantial, complex undertaking that elicited thousands of comments and a lot of pressure from opponents and proponents. Then, in July, came another challenge, as SCOTUS handed down West Virginia v EPA, which, although not directly addressing the SEC’s climate proposal, sure seemed to put a bull’s eye on it. (See this PubCo post.) Not to mention the SEC’s technical glitch, which led to a reopening of the comment period for a couple of weeks until November 1. (See this PubCo post.) That alone would have been enough to smoke the October target date set in the most recent SEC agenda. (See this PubCo post.) But what is real timeframe? Well, who knows. According to Bloomberg, SEC Chair Gary “Gensler has declined to give a timeline for finishing the climate regulations in recent public appearances, repeatedly pointing to thousands of comments that still need to be reviewed.” Bloomberg also reports that SEC “officials in private conversations have given no indication they’ll finish the rules this year, according to several people in contact with the agency.”
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