Relentless Inc. v. Dept. of Commerce: SCOTUS grants cert. to another case about Atlantic herring—and Chevron deference
On October 13, SCOTUS granted cert. in the case of Relentless, Inc. v. Dept of Commerce, a case about whether the National Marine Fisheries Service has the authority to require herring fishing vessels to pay some of the costs for onboard federal observers who are required to monitor regulatory compliance. Does that ring a bell? Probably, because it’s exactly the same issue on which SCOTUS has already granted cert. in Loper Bright Enterprises v. Raimondo. (See this PubCo post.) Why grant cert. in this case too? It’s been widely reported that the reason was to allow Justice Kenji Brown Jackson, who had recused herself on Loper Bright, to participate in what will likely be a very important decision: whether the Court should continue the decades-long deference of courts, under Chevron U.S.A., Inc. v. Nat. Res. Def. Council, to the reasonable interpretations of statutes by agencies (such as the National Marine Fisheries Service or, as has happened fairly often, the SEC, see this Cooley News Brief). The question presented is “ [w]hether the Court should overrule Chevron or at least clarify that statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute an ambiguity requiring deference to the agency.” The decision could narrow, or even completely undo, that deference. The grant of cert provided that the two cases will be argued in tandem in the January 2024 argument session. Mark your calendars.
On Friday, August 6, 2021, the SEC approved a Nasdaq proposal for new listing rules regarding board diversity and disclosure, accompanied by a proposal to provide free access to a board recruiting service. 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.) As anticipated, a court challenge to these rules didn’t take long to materialize. On Monday, August 9, the Alliance for Fair Board Recruitment filed a slim petition under Section 25(a) of the Exchange Act in the Fifth Circuit Court of Appeals—the Alliance has its principal place of business in Texas—for review of the SEC’s final order approving the Nasdaq rule. (See this PubCo post.) That petition was soon followed by a new petition challenging the rules filed by the National Center for Public Policy Research and subsequently transferred to the Fifth Circuit where the earlier filed petition was pending. (See this PubCo post.) Yesterday, a three-judge panel of the Fifth Circuit—by repute, the Circuit of choice for advocates of conservative causes—denied those petitions, in effect upholding Nasdaq’s board diversity listing rules. According to the unanimous decision, “AFBR and NCPPR have given us no reason to conclude that the SEC’s Approval Order violates the Exchange Act or the APA.” The case is Alliance for Fair Board Recruitment, National Center for Public Policy Research v. SEC.
After all the PubCo posts on the avalanche of SEC enforcement cases muscled into the last couple of days before the SEC’s fiscal year end, I thought this column in Bloomberg from Matt Levine might be of particular interest. The relevant portion of the column, called the “SEC silly season,” discusses the apparent scramble by the SEC at the end of its fiscal year to bring as many enforcement actions as possible in response to “performance-reporting pressures,” that is, the pressures to make its stats to achieve optimal Congressional funding. According to academic research cited in the column, that scramble is not just “apparent,” it’s real, and it has practical implications for enforcement behavior. The research showed that the average number of cases filed in September “is almost double the average in other months,” and that the “spike is larger when case totals are behind pace to meet last year’s case total, which likely serves as a de facto performance benchmark.” The SEC achieves this fiscal-year-end increase, according to the research, “by changing its enforcement behavior related to substantive cases,” that is, through prioritization of less complex cases and imposition of more lenient penalties, including financial discounts, relative to other periods. For example, the September cases are “significantly more likely to reference defendant cooperation and to only name companies as defendants, and are less likely to include a fraud allegation and to reference parallel criminal proceedings.” Accordingly, the authors found that the “evidence is consistent with the SEC agreeing to more lenient settlement terms to increase case volume at fiscal year-end—an unintended consequence of performance reporting that undermines the SEC’s core values.” As the authors of the research suggest, might defendants familiar with this “regulatory inconsistency” be able to use it to their advantage?
You remember Matt Levine’s mantra in his “Money Stuff” column on Bloomberg: “everything is securities fraud”? “You know the basic idea,” he says, a
“company does something bad, or something bad happens to it. Its stock price goes down, because of the bad thing. Shareholders sue: Doing the bad thing and not immediately telling shareholders about it, the shareholders say, is securities fraud. Even if the company does immediately tell shareholders about the bad thing, which is not particularly common, the shareholders might sue, claiming that the company failed to disclose the conditions and vulnerabilities that allowed the bad thing to happen. And so contributing to global warming is securities fraud, and sexual harassment by executives is securities fraud, and customer data breaches are securities fraud, and mistreating killer whales is securities fraud, and whatever else you’ve got. Securities fraud is a universal regulatory regime; anything bad that is done by or happens to a public company is also securities fraud, and it is often easier to punish the bad thing as securities fraud than it is to regulate it directly.” (Money Stuff, 6/26/19)
(See this PubCo post.) But here’s a new one—bribery and political corruption as securities fraud. As described in this press release, in the fiscal-year-end enforcement crush, the SEC brought settled charges against Exelon Corporation, a utility services holding company, and its subsidiary, electric utility company Commonwealth Edison Company (ComEd), and filed a complaint against ComEd’s former CEO alleging “fraud in connection with a multi-year scheme to corruptly influence and reward the then-Speaker of the Illinois House of Representatives.” Exelon and ComEd agreed to settle the charges, with Exelon paying a civil penalty of $46.2 million. The charges against the CEO are headed for trial. So how is this securities fraud? According to the Chief of the SEC Enforcement Division’s Public Finance Abuse Unit, the CEO’s “remarks to investors about ComEd’s lobbying efforts hid the reality of the long-running political corruption scheme in which they were engaged….When corporate executives speak to investors, they must not mislead by omission.”
As part of its fiscal-year-end enforcement surge, the SEC filed charges against three former executives of Pareteum Corporation, a telecommunications and cloud software company, for fraudulent revenue recognition practices—a settled action against the former controller and a complaint against the former CFO and former Chief Commercial Officer (also, formerly CEO). As described in the complaint, the SEC charged the former executives with orchestrating a fraudulent scheme to overstate revenue by recording revenue from non-binding purchase orders and concealing the practice from the company’s auditors. From 2018 through mid-2019, the SEC alleged, the defendants’ improper revenue recognition practices resulted in the company’s overstating revenue by “approximately $12 million for fiscal year 2018 (60% of the ultimately restated revenue), and by approximately $30 million for the first and second quarters of 2019 (91% of the ultimately restated revenue).” In addition, the former CFO, the SEC charged, did not establish sufficient internal accounting controls to assess whether revenue should be recognized under GAAP. According to the press release, Pareteum previously settled with the SEC on accounting and disclosure fraud charges in 2021 and filed for bankruptcy in 2022. Notably, the U.S. Attorney’s Office for the SDNY has announced parallel criminal charges against the former CFO and CCO. According to the Associate Director of Enforcement for the SEC’s Philadelphia Regional Office, as the SEC alleged in its complaint, “Pareteum’s executives artificially inflated Pareteum’s revenue numbers to create the illusion of robust revenue growth….Investors should be able to trust public companies to issue truthful and accurate financial statements, and we will hold accountable any executives who abuse that trust and defraud investors.”
In this settled action, the SEC charged Newell Brands and its former CEO with providing misleading disclosure about a prominently featured non-GAAP financial measure—“core sales,” a key NGFM that Newell portrayed as providing “a more complete understanding of underlying sales trends.” As described in the Order and press release, Newell and its CEO took a number of actions—reclassifications, accrual reductions, order pull-forwards—that increased “core sales” growth, but the resulting increases “were out of step with Newell’s actual but undisclosed sales trends, allowing the company to announce ‘strong’ or ‘solid’ results in quarters it internally described as disappointing due to shortfalls in sales.” In fact, the SEC charged, Newell misled investors, depriving them of “information relevant to an accurate and complete understanding of Newell’s actual sales trends.” Moreover, in Newell’s effort to manage revenues, what began as tinkering with an NGFM metastasized into problems with GAAP accounting. According to the Associate Director of Enforcement, the SEC found that “Newell’s former CEO issued an instruction to ‘scrub’ the company’s accruals after he learned that the company was projecting a ‘massive’ and ‘disappointing’ miss for the quarter….Senior executives of public companies hold positions of trust, and they risk abusing the duties attendant to their offices when they reach into a company’s accounting control processes as a way of making up for performance shortfalls.” Newell agreed to pay a civil penalty of $12.5 million and its CEO to pay $110,000.
The rubber meets the road again—inflated sales, inflated projections charged at electric vehicle manufacturers
Is it Groundhog Day again? Haven’t we heard about this before? An electric vehicle manufacturer that went public through a SPAC transaction is charged by the SEC with fraudulently misrepresenting the status of its products, even posting a misleading video of a truck purportedly operating on hydrogen fuel when it did not. But no, it’s not Nikola Corporation (see this PubCo post). Just this past week, in the rush to beat the shutdown and fortify the SEC’s fiscal year-end statistics, Enforcement announced two settled actions against two manufacturers of electric vehicles for misleading investors. In the first case, Hyzon Motors Inc., a maker of hydrogen fuel cell electric vehicles (FCEVs), was charged with misleading investors about the status of Hyzon’s products, business relationships and vehicle sales, agreeing to pay a civil penalty of $25 million. Two executive officers, also charged, agreed to pay civil penalties of $100,000, and $200,000. Not to mention a restatement to reverse revenue improperly recognized. According to a Regional Director, “[t]ransparency in the form of full, fair, and accurate disclosure is fundamental to the federal securities laws….The defendants allegedly violated this principle by misleading investors about virtually every aspect of Hyzon’s business.” [Emphasis added.] In the second case, the predecessor to Spruce Power Holding Corporation, XL Fleet, which provided fleet hybrid electrical vehicles, was alleged to have misled investors about its sales pipeline and revenue projections. As the successor, Spruce agreed to pay a civil penalty of $11 million. According to the Associate Director of Enforcement, “[i]t goes without saying that investors commonly rely on revenue projections when deciding how and where to invest, and that’s perhaps especially true for investment decisions involving early-stage companies in the SPAC market….By linking its bold revenue projections to misleading claims about the company’s historical performance, XL Fleet misled investors by inhibiting their ability to differentiate between credible facts and mere aspiration.” It’s worth noting here that, in March last year, the SEC proposed new rules regarding SPACs, including rules related to the use of projections in SEC filings “to address concerns about their reliability.” (See this PubCo post.)
In an enforcement sweep, SEC charges multiple companies and insiders with untimely reporting under Sections 16 and 13(d)
Yesterday, the SEC announced a sweep enforcement action against several insiders and companies for failing to file Forms 4 (Section 16(a) short-swing trading reports) and Schedules 13D and G (reports by beneficial owners of more than 5%) on a timely basis. Using data analytics, the SEC staff identified the insiders charged as “repeatedly filing these reports late,” some delayed “by weeks, months, or even years.” In some cases, the companies failed to make filings on behalf of insiders after having volunteered to do so, and then failed to report the delinquencies in their own filings, as required by Reg S-K Item 405. Those charged were assessed penalties ranging from $66,000 to $200,000. In commenting on these cases, SEC Director of Enforcement Gurbir Grewal said that “[t]imely disclosure of insider transactions is critically important to both investors and the fair, orderly and efficient operation of our securities markets. According to today’s orders, the insiders and companies charged in these matters in the aggregate deprived investors of timely information about over $90 million in transactions….These enforcement actions also make clear that we will not hesitate to charge companies for causing their insiders’ disclosure violations where the companies took on the responsibility for making relevant filings for their insiders, and then acted negligently.” According to the Deputy Enforcement Director, “[s]everal years ago, we undertook a similar initiative to root out repeated late filers….Today’s enforcement action should serve to remind SEC filers that reporting obligations under the securities laws are not optional, and there are consequences for failing to file required forms in a timely manner.” Apparently, the SEC wants to send a message that late filings are not ok…and really late filing are really not ok. It’s also clear that the SEC views companies that do volunteer to make filings on behalf of their insiders—a common practice—as potentially contributing to their filing failures and will hold the companies responsible if the insiders fail to timely file. Message sent, message received?
This press release announces settled charges brought by the SEC against GTT Communications, Inc., a multinational telecommunications and internet service provider, for failure to disclose material information about “unsupported adjustments of more than $35 million” that had the effect of reducing COR, i.e., cost of revenue, and increasing reported operating income by at least 15% in three quarters from 2019 through 2020. According to the Order, in 2017 and 2018, GTT rapidly expanded its business through multiple acquisitions, but had difficulty absorbing and integrating the operations of the acquired, sometimes distressed, companies, especially with regard to accounting and controls. As a result, GTT was never able to reconcile data from two critical operating systems used to determine COR, ultimately leading to data integrity issues in its financial statements. In an attempt to achieve some consistency between the two systems, the SEC alleged, the company began to make accounting adjustments that, in the absence of effective controls, were “highly uncertain” and devoid of proper support. Moreover, the SEC alleged, GTT failed to provide adequate disclosure about the adjustments. In addition to antifraud violations, the SEC charged GTT with control violations: although GTT knew that its systems were inadequate to accurately report COR, “GTT failed to implement and maintain policies and procedures designed to provide reasonable assurance that the COR reflected in GTT’s financial statements was based on reasonable support.” However, because of GTT’s prompt self-reporting, remedial measures and substantial cooperation, the SEC did not impose a civil penalty. But perhaps the real penalty can be found here: in 2021, GTT was delisted from the NYSE, terminated its Exchange Act registration and filed for bankruptcy. GTT emerged in 2022 as a private company owned by certain of its former creditors—but eligible to use “Fresh-Start Reporting.”
One area where SEC Enforcement appears to have focused its attention recently is whistleblower protections. In this Order against CBRE, Inc., the SEC brought settled charges against the commercial real estate services and investment firm for using an employee release form that the SEC alleged violated Exchange Act Rule 21F-17, the SEC’s whistleblower protection rule. The purpose of the whistleblower provisions in the Exchange Act, added in 2010 as part of Dodd-Frank, was to “encourage whistleblowers to report possible securities law violations by providing, among other things, financial incentives and confidentiality protections.” To prevent obstruction of that reporting, the SEC adopted Rule 21F-17, which provides that “[n]o person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement…with respect to such communications.” The SEC’s order found that, “by conditioning separation pay on employees’ signing the release, CBRE took action to impede potential whistleblowers from reporting complaints to the Commission.” According to an SEC Regional Director, it “is critical that employees are able to communicate with SEC staff about potential violations of the federal securities laws without compromising their financial interests or the confidentiality protections of the SEC’s whistleblower program….We commend CBRE for its swift and far-reaching remediation and for its high level of cooperation with our staff, which is reflected in the terms of the resolution.” Is it time to take another look at your employee separation agreements and release forms?