The “737 MAX is as safe as any airplane that has ever flown the skies”— Boeing settles antifraud charges with SEC
In a kind of sad coda to the litany of claims, charges, investigations and litigation surrounding the tragic crashes in 2018 and 2019 of two Boeing 737 MAX airplanes and the heartbreaking deaths of 346 passengers, the SEC announced last week, as discussed in this Order, that the Boeing Company had agreed to pay $200 million to settle charges that it made materially misleading statements following the crashes, including statements assuring the public that the 737 MAX airplane was “as safe as any airplane that has ever flown the skies.” (As discussed in this order, the CEO will pay $1 million to settle charges.) Of course, that settlement pales against the $2.5 billion settlement agreed on last year with Department of Justice to resolve a criminal charge related to a conspiracy to defraud the FAA in connection with the FAA’s evaluation of the Boeing’s 737 MAX airplane. Also last year, as reported by the NYT, Boeing’s directors reached a $237.5 million settlement of Caremark claims filed in Delaware, which asserted that, as a result of the directors’ “complete failure to establish a reporting system for airplane safety,” and “their turning a blind eye to a red flag representing airplane safety problems,” the board consciously breached its fiduciary duty and violated corporate responsibilities and, as a result, should bear some responsibility for Boeing’s losses. (For a discussion of that case, see this PubCo post.) According to SEC Chair Gary Gensler, “[t]here are no words to describe the tragic loss of life brought about by these two airplane crashes….In times of crisis and tragedy, it is especially important that public companies and executives provide full, fair, and truthful disclosures to the markets. The Boeing Company and its former CEO, Dennis Muilenburg, failed in this most basic obligation. They misled investors by providing assurances about the safety of the 737 MAX, despite knowing about serious safety concerns. The SEC remains committed to rooting out misconduct when public companies and their executives fail to fulfill their fundamental obligations to the investing public.” How do these things happen? The facts of the Boeing case may be instructive.
It may look like just another run-of-the-mill insider trading case, but there’s one difference in this settled SEC Enforcement action: according to the SEC, it involved sales under a purported 10b5-1 trading plan while in possession of material nonpublic information. As you probably know, to be effective in insulating an insider from potential insider trading liability, the 10b5-1 plan must be established when the insider is acting in good faith and not aware of MNPI. Creating the plan when the insider has just learned of MNPI, as alleged in this Order, well, kinda defeats the whole purpose of the rule. That’s not how it’s supposed to work, and the two executives involved here—the CEO and President/CTO of Cheetah Mobile—found that out the hard way, with civil penalties of $556,580 and $200,254. The company’s CEO was also charged with playing a role in the company’s misleading statements and disclosure failures surrounding a material negative revenue trend. According to the Chief of the SEC Enforcement Division’s Market Abuse Unit in this press release, “[w]hile trading pursuant to 10b5-1 plans can shield employees from insider trading liability under certain circumstances, these executives’ plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it.”
Last week, the SEC brought a settled action against VMware, a provider of cloud-storage software and services, alleging that it misled shareholders by failing to disclose material information about its “managed pipeline” of orders in quarterly and annual Exchange Act reports, on earnings calls and in earnings releases during its 2019 and 2020 fiscal years. According to the press release, the company used its “backlog management practices” to “push revenue into future quarters by delaying product deliveries to customers, concealing the company’s slowing performance relative to its projections.” Interestingly, the charges in the SEC’s Order were not about funny accounting or even that favorite Enforcement standby, failure to maintain and comply with adequate disclosure controls and procedures. As VMware noted in a statement, the “SEC’s findings do not include any findings that the Company failed to comply with generally accepted accounting principles.” Rather, the charges were about the disclosures about the accounting. “Although VMware publicly disclosed that its backlog was ‘managed based upon multiple considerations,’” the SEC said, “it did not reveal to investors that it used the backlog to manage the timing of the company’s revenue recognition.” VMware was ordered to cease and desist and pay a civil penalty of $8 million. According to an Associate Director in the Division of Enforcement, “by making misleading statements about order management practices, VMware deprived investors of important information about its financial performance….Such conduct is incompatible with an issuer’s disclosure obligations under the federal securities laws.”
Reg FD cases rarely get to court, but here’s one that, barring a settlement, appears to be headed to trial. In a 129-page opinion in SEC v. AT&T, 9/08/22, the federal district court for the SDNY denied summary judgment for both sides in a case the SEC brought in March of 2021 against AT&T and three members of its Investor Relations Department for violations of Reg FD. (See this PubCo post.) The SEC alleged that, in March 2016, AT&T learned that, as a result of a “steeper-than-expected decline in smartphone sales,” AT&T’s first quarter revenues would fall short of analysts’ estimates by over a $1 billion. Given that AT&T had missed consensus revenue estimates in two of the three preceding quarters, AT&T, it was alleged, embarked on a “campaign” to beat consensus revenue estimates for Q1: the three defendant IR employees were asked by the CFO and IR Director to contact the analysts whose estimates were too high to “walk” them down. As part of that campaign, the SEC alleged, they selectively disclosed the company’s “projected or actual total revenue, and internal metrics bearing on total revenue, including wireless equipment revenue and wireless equipment upgrade rates.” The campaign worked. But—and it’s a big but—it also led the SEC to bring claims against AT&T for violating Reg FD, and against the three IR employees for aiding and abetting that violation. As to AT&T and the other defendants, the Court was not persuaded by their arguments that there was insufficient evidence to support the SEC’s claims of a Reg FD violation, nor did the Court agree that Reg FD was “invalid” under the First Amendment. And, as to the SEC, while the Court viewed as “formidable” the evidence showing that the information at issue was material, nonpublic and selectively disclosed, the question of scienter was a closer one, and a reasonable jury could find for the defendants on that point.
On Friday, the SEC, without holding an open meeting, adopted two amendments to the whistleblower program that had been proposed in February. The vote was three to two. Under the SEC’s whistleblower program, the SEC may “make monetary awards to eligible individuals who voluntarily provide original information that leads to successful SEC enforcement actions resulting in monetary sanctions exceeding $1 million and certain successful related actions.” Awards must be in the range of 10% to 30% of the monetary sanctions collected. The two new amendments relate to changes that had been adopted in 2020 regarding awards under related programs and award amounts. According to SEC Chair Gary Gensler, the amendments will “help enhance the whistleblower program. The first amendment expands the circumstances in which a whistleblower who assisted in a related action can receive an award from the Commission for that related action rather than from the other agency’s whistleblower program. The second amendment concerns the Commission’s authority to consider and adjust the dollar amount of a potential award. Under today’s amendments, when the Commission considers the size of the would-be award as grounds to change the award amount, it can do so only to increase the award, and not to decrease it. This will give whistleblowers additional comfort knowing that the Commission would not decrease awards based on their size….I think that these rules will strengthen our whistleblower program. That helps protect investors.” The amendments to the whistleblower rule will become effective 30 days after publication in the Federal Register.
After the murder of George Floyd in 2020 and the national protests that it triggered, many of the country’s largest corporations expressed solidarity and pledged support for racial justice and racial and ethnic diversity, equity and inclusion. Some institutional investors also beefed up their proxy voting policies, demanding both greater transparency and more racial and ethnic diversity. One place that companies looked to implement their commitments to DEI was at the board level. Now, about two years after that horrific event, how much progress have companies made? Using the end of proxy season in 2020 as a starting point, ISS has some recent data. ISS concludes that, while substantial progress has been made in board racial and ethnic diversity, “many boards still do not reflect the diversity of their customer base or the demographics of the broader society in which they operate.”
The SEC has posted its Spring 2022 Reg-Flex agenda and it’s crammed with pending and new rulemakings—and they’re all going to be proposed or adopted in October! (Ok, admittedly, that’s an exaggeration, but not much of one.) Here is the short-term agenda and here is the long-term agenda. According to SEC Chair Gary Gensler, the “U.S. is blessed with the largest, most sophisticated, and most innovative capital markets in the world….But we cannot take that for granted. As SEC alum Robert Birnbaum and his team said decades ago, ‘no regulation can be static in a dynamic society.’ That core idea still rings true today.” Gensler’s public policy goals for the agenda are “continuing to drive efficiency in our capital markets and modernizing our rules for today’s economy and technologies.” As with recent prior agendas, SEC Commissioner Hester Peirce has almost no kind words for the agency’s plans—“flawed goals and a flawed method for achieving them.” In fact, she went so far as to characterize the agenda as “dangerous”: in her view, the agenda represents “the regulatory version of a rip current—fast-moving currents flowing away from shore that can be fatal to swimmers. Just as certain wave and wind conditions can create dangerous rip currents, the pace and character of the rulemakings on this agenda make for dangerous conditions in our capital markets.” There’s no dispute that the agenda is laden with major proposals—human capital, SPACs, board diversity. What’s more, many of these proposals—climate disclosure, cybersecurity, Rule 10b5-1—are apparently at the final rule stage. Whether or not we’ll see a load of public companies submerged by the rip tide of rulemakings remains to be seen, but there’s not much question that implementing them all would certainly be a challenge in any case.
Jarkesy and climate disclosure: how far will the courts go in constraining the administrative state?
On Wednesday, in an Expert Forum sponsored by Cornerstone Research, Stanford professor and former SEC Commissioner Joe Grundfest and Vice Chair and Chief Legal Officer of Millennium Management and former SEC General Counsel Simon Lorne discussed “The Evolving SEC Landscape: Jarkesy v. SEC and the Proposed Climate Rules.” The two seemingly disparate topics were united by a common thread—the intense skepticism exhibited by some courts (including a likely majority of SCOTUS) of the vast power of the administrative state and their undisguised enthusiasm to constrain it. As Grundfest put it, in a slightly different context, the words are different but the melody is the same. What will be the impact?
The California Secretary of State has announced that she has directed counsel to file an appeal of the May 13 verdict of the Los Angeles Superior Court in Crest v. Padilla, which ruled unconstitutional SB 826, California’s board gender diversity statute. Crest v. Padilla was filed in 2019 by three California taxpayers seeking to prevent implementation and enforcement of the law. Framed as a “taxpayer suit,” the litigation sought a judgment declaring the expenditure of taxpayer funds to enforce or implement SB 826 to be illegal and an injunction preventing the California Secretary of State from expending taxpayer funds for those purposes, alleging that the law’s mandate was an unconstitutional gender-based quota and violated the Equal Protection Provisions of the California Constitution. After a bench trial, the Court agreed with the plaintiffs and enjoined implementation and enforcement of the statute. (See this PubCo post.) This verdict follows summary judgment in favor of the same plaintiffs in their case against AB 979, California’s board diversity statute regarding “underrepresented communities,” which was patterned after the board gender diversity statute. (See this PubCo post.)
You might remember that the first legal challenge to SB 826, California’s board gender diversity statute, Crest v. Alex Padilla, was a complaint filed in 2019 in California state court by three California taxpayers seeking to prevent implementation and enforcement of the law. Framed as a “taxpayer suit,” the litigation sought a judgment declaring the expenditure of taxpayer funds to enforce or implement SB 826 to be illegal and an injunction preventing the California Secretary of State from expending taxpayer funds and taxpayer-financed resources for those purposes, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution. A bench trial began in December in Los Angeles County Superior Court that was supposed to last six or seven days, but closing arguments didn’t conclude until March. (See this PubCo post.) The verdict from that Court has just come down. The Court determined that SB 826 violates the Equal Protection Provisions of the California Constitution and enjoined implementation and enforcement of the statute. This verdict follows summary judgment in favor of the same plaintiffs in their case against AB 979, California’s board diversity statute regarding “underrepresented communities,” which was patterned after the board gender diversity statute. (See this PubCo post.) The Secretary of State has not yet indicated whether there will be an appeal. In light of pressures from institutional investors and others for board gender diversity, together with the Nasdaq “comply or explain” board diversity rule (see the SideBar below), what impact the decision will have on board composition remains to be seen.