In this Enforcement Order, the SEC described a “revenue management scheme” orchestrated by the respondent, Marvell Technology Group, and the imposition on Marvell of a $5.5 million penalty and cease-and-desist order—not because of the scheme itself, but rather because the company failed to publicly disclose the scheme in its MD&A or to discuss its likely impact on future performance. The Order demonstrates that, even if a scheme involving unusual sales practices may not amount to chargeable accounting fraud, failure to disclose its distortive effects can be misleading and result in violations of the Securities Act and Exchange Act.
Reg FD prohibits selective disclosure of material, nonpublic information by public companies (or by its senior officials or specified other employees) to securities market professionals and shareholders reasonably likely to trade on the information. If a public company does make a disclosure of that kind, the company is required under Reg FD to disclose the information to the public. Information is considered “material” if there is “a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or if the information would significantly alter the total mix of available information.” And that’s where the thorny part comes in. The test for materiality is a subjective one, based on the facts and circumstances. But judgments about materiality of disclosures are often complicated and muddy and frequently made in real time.
At the end of last week, the SEC voted, without an open meeting, to propose amendments to modernize the descriptions of business, legal proceedings and risk factors in Reg S-K. The proposal is another component of the SEC’s “Disclosure Effectiveness Initiative.” In crafting the proposal, the SEC took into account comments received on the 2016 Concept Release on disclosure simplification and modernization (see this PubCo post), as well as Corp Fin staff experience in review of disclosures. The changes to the rules were proposed “in light of the many changes that have occurred in our capital markets and the domestic and global economy in the more than 30 years since their adoption, including changes in the mix of businesses that participate in our public markets, changes in the way businesses operate, which may affect the relevance of current disclosure requirements, changes in technology (in particular the availability of information), and changes such as inflation that have occurred simply with the passage of time.” There is a 60-day comment period.
It was only a matter of time. As reported here on Bloomberg, a conservative activist group has filed a lawsuit, Crest v. Alex Padilla, in California state court on behalf of three California taxpayers seeking to prevent implementation and enforcement of SB 826, California’s Board gender diversity legislation. This appears to be the first litigation filed to challenge the new law. Framed as a “taxpayer suit,” the litigation seeks to enjoin Alex Padilla, the California Secretary of State, from expending taxpayer funds and taxpayer-financed resources to enforce or implement the law, alleging that the law’s mandate is an unconstitutional gender-based quota and violates the California constitution.
No, it’s not an episode of Top Chef, but it is about “cooking the books.” And those are just some of the ingredients and tools used by Brixmor Property Group, a publicly traded REIT, and four of its executives to do the cooking: manipulation of a key non-GAAP financial measure, according to this SEC complaint and order and, even more to the point, this SDNY criminal indictment of the executives. As alleged, management sought to create the impression that a static pool of its existing properties showed steady and predictable income growth across a number of quarters. In contrast, however, Brixmor’s actual income growth rate was “volatile and frequently fell above or below the company’s publically issued guidance range” for the period. So, according to the order, the company architected the desired illusion—touted as its “secret sauce”—by engaging in some “sausage-making” with regular hits to the “cookie jar.” While it doesn’t sound very appetizing, it did create the desired deception—until, of course, it didn’t. The lesson is that manipulation of a non-GAAP measure, together with violations of GAAP, to mislead the public can be trouble—and perhaps even criminal. Although cases of accounting fraud may not be as common as they once were, this case should serve as a reminder that the SEC and the Justice Department are still on the lookout for it.
Delaware Supreme Court allows Caremark duty of loyalty claims against directors to survive dismissal motion
In Marchand v. Barnhill (June 18, 2019), soon-to-be-retired Chief Justice Strine, writing for the Delaware Supreme Court, started out his analysis with the recognition that “Caremark claims are difficult to plead and ultimately to prove out,” and constitute “possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment.” That’s a rather high bar. What does it take to plead a Caremark case that can survive a motion to dismiss? Marchand provides an illustration—and a warning that directors should be proactive in conducting risk oversight and could face liability if they fail to “make a good faith effort to implement an oversight system and then monitor it.”
In February 2018, SCOTUS handed down its decision in Digital Realty v. Somers, holding that the Dodd-Frank whistleblower anti-retaliation protections apply only if the whistleblower blows the whistle all the way to the SEC; internal reporting to the company alone would not suffice. As Justice Gorsuch remarked during oral argument, the Justices were largely “stuck on the plain language” of the statute. However, by requiring SEC reporting as a predicate, it was widely thought that the decision might have a somewhat perverse impact: while the win by Digital would limit the liability of companies under Dodd-Frank for retaliation against whistleblowers who did not report to the SEC, the holding that whistleblowers were not protected unless they reported to the SEC could well discourage internal reporting by driving all securities-law whistleblowers directly to the SEC to ensure their protection from retaliation under the statute—which just might not be a consequence that many companies would favor. (See this PubCo post.)
The Department of Justice has just released its updated guidance for Evaluation of Corporate Compliance Programs. The DOJ Manual identifies factors that prosecutors take into account “in conducting an investigation of a corporation, determining whether to bring charges, and negotiating plea or other agreements.” Among these factors is the “adequacy and effectiveness of the corporation’s compliance program.” Although the guidance is designed to assist prosecutors in assessing and making informed decisions about the extent of “credit” to be attributed to a company in light of its corporate compliance program, the factors that prosecutors are advised to consider in evaluating these programs should not be lost on companies seeking to develop and implement their own compliance programs. Of course, the guidance is not intended to be formulaic and recognizes that the relevance and significance of the factors and questions identified will vary depending on a range of company attributes, including “each company’s risk profile and solutions to reduce its risks.”
SCOTUS finds primary securities fraud liability for disseminating statements made by others with intent to defraud
Last week, SCOTUS decided Lorenzo v. SEC, a case involving a claim that an investment banker was liable for securities fraud when, at the direction of his boss, he cut, pasted and disseminated to potential investors information that his boss had provided, even though the banker knew the information was false. In a 2011 case, Janus Capital Group, Inc. v. First Derivative Traders, SCOTUS had held that, an “investment adviser who had merely ‘participat[ed] in the drafting of a false statement’ ‘made’ by another could not be held liable in a private action under subsection (b) of Rule10b–5.” (Rule 10b–5(b) prohibits the “mak[ing]” of “any untrue statement of a material fact.”) In Lorenzo, the question before the Court was whether a person who did not “make” statements (that is, who did not have “ultimate authority” over the statements), but who knowingly disseminated false statements to potential investors with intent to defraud, could be found to have violated subsections (a) and (c) of Rule 10b–5. The answer, in an opinion written by Justice Breyer, was yes. Will this case embolden plaintiff’s counsel to push the envelope and assert claims against people who are only peripherally involved in the dissemination of allegedly false information? Time will tell what the ultimate impact of this case may be.
You might remember this no-action letter to Johnson & Johnson granting relief to the company if it relied on Rule 14a-8(i)(2) (violation of law) to exclude a shareholder proposal requesting adoption of mandatory shareholder arbitration bylaws. (See this PubCo post.) In that letter, the staff relied on an opinion from the Attorney General of the State of New Jersey, the state’s chief legal officer, which advised the SEC that the proposal was excludable under Rule 14a-8(i)(2) because “adoption of the proposed bylaw would cause Johnson & Johnson to violate applicable state law.” The issue was so fraught that SEC Chair Jay Clayton felt the need to issue a statement supporting the staff’s hands-off position: “The issue of mandatory arbitration provisions in the bylaws of U.S. publicly-listed companies has garnered a great deal of attention. As I have previously stated, the ability of domestic, publicly-listed companies to require shareholders to arbitrate claims against them arising under the federal securities laws is a complex matter that requires careful consideration,” consideration that would be more appropriate at the Commissioner level than at the staff level. However, mandatory arbitration was not an issue that he was anxious to have the SEC wade into at that time. To be sure, if the parties really wanted a binding answer on the merits, he suggested, they might be well advised to seek a judicial determination. And, you guessed it—Clayton’s words to the proponent’s ears—the proponent filed this complaint on March 21.