Category: Litigation
SEC brings settled charges against Roadrunner—no, not the cartoon character—for accounting fraud
Here’s another earnings management case from SEC Enforcement, this time against Roadrunner Transportation Systems, Inc., a shipping and logistics company formerly traded on the NYSE, involving a veritable pu pu platter of alleged financial manipulations. As charged in the SEC’s Order, from July 2013 through January 2017, the company engaged in an “accounting fraud scheme by manipulating its financial reports to hit prior earnings guidance and analyst projections.” Among other things, Roadrunner was alleged to have improperly deferred and stretched out expenses over multiple quarters to minimize their impact on earnings, failed to write down worthless assets and uncollectable receivables, and manipulated earnout liabilities related to its numerous acquisitions. The company agreed to pay disgorgement of just over $7 million, with prejudgment interest of approximately $2.5 million—except that the company paid nothing additional: the penalties were deemed satisfied by the settlement payment the company made in connection with prior private securities litigation.
DOJ announces nationwide voluntary self-disclosure policy
On Wednesday, the DOJ announced a new Voluntary Self-Disclosure Policy, which sets out the criteria for determining when a company is deemed to have made a voluntary self-disclosure of misconduct to a US Attorney’s Office and how the company might benefit from a “resolution under more favorable terms.” According to the press release, the policy is intended to provide “transparency and predictability to companies and the defense bar concerning the concrete benefits and potential outcomes in cases where companies voluntarily self-disclose misconduct, fully cooperate, and timely and appropriately remediate. The goal of the policy is to standardize how VSDs are defined and credited by USAOs nationwide, and to incentivize companies to maintain effective compliance programs capable of identifying misconduct, expeditiously and voluntarily disclose and remediate misconduct, and cooperate fully with the government in corporate criminal investigations.”
SEC Enforcement’s “EPS Initiative” chalks up another one
Last week, the SEC announced settled charges against Gentex Corporation, a manufacturer of digital vision, connected car, dimmable glass and fire protection products, and its former Chief Accounting Officer and current CFO, Kevin Nash, related to financial reporting, books-and-records and internal accounting controls violations. Allegedly, these violations were the consequence of deficiencies in the company’s accounting practices for its bonus programs, which practices allowed the company to manage its earnings by adjusting its accruals for bonuses to ensure that publicly reported EPS was in line with consensus EPS estimates—without the required accounting analysis or adequate supporting documentation. According to the SEC, had the company not reduced the accrual for bonuses, it “would have missed consensus EPS estimates by one penny.” Gentex was ordered to pay a civil money penalty of $4 million and Nash to pay $75,000. These charges represent yet another case resulting from SEC Enforcement’s “Earnings-Per-Share Initiative,” which applies risk-based data analytics to detect potential violations from earnings management, among other things.
SEC floats dialing back climate disclosure rules
The SEC has apparently let it be known—or perhaps a few reporters are especially intrepid—that it may well pare down and loosen up some of its proposed rules on climate disclosure (see this PubCo post, this PubCo post and this PubCo post). In this article in Politico and this article in the WSJ, “three people familiar with the matter” and “people close to the agency” told reporters that SEC Chair Gary Gensler is “considering scaling back a potentially groundbreaking climate-risk disclosure rule that has drawn intense opposition from corporate America.” According to Politico, SEC officials “stress that no decision has yet been made,” so time will tell where the final rulemaking will end up.
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.”
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