Tag: SEC Division of Enforcement

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.’” 

SEC charges Compass Minerals with disclosure violations resulting from “deficient disclosure process”

Toward the end of last month, the SEC announced settled charges against Compass Minerals International, Inc., for alleged disclosure violations that were “the consequence of a deficient disclosure process.”   In the Order, the SEC alleged that Compass misrepresented the impact of a technology upgrade at its Goderich mine—the world’s largest underground salt mine—which the company had claimed would lead to cost savings, but actually led to increased costs and below-expectation results.  Central to the case, however, was the purported failure of the company’s disclosure controls that resulted in the misleading statements: “statements to investors were not reviewed by personnel who were sufficiently knowledgeable about both Compass’s operations and its disclosure obligations.” The company was also charged with failing to disclose the potential financial risks arising out of the company’s contamination of a river in Brazil with excessive discharges of mercury, a failure the SEC also attributed to inadequate disclosure controls.  According to Melissa Hodgman, Associate Director of the Division of Enforcement, “[w]hat companies say to investors must be consistent with what they know. Yet Compass repeatedly made public statements that did not jibe with the facts on—or under—the ground at Goderich….By misleading investors about mining costs in Canada and failing to analyze the potential financial consequences of its environmental contamination in Brazil, Compass fell far short of what the federal securities laws require.” Compass agreed to pay $12 million to settle the charges. 

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.

SEC charges executives with insider trading— purported 10b5-1 plan provided no defense

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.”

VMware charged with failure to disclose “backlog management practices”

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.” 

SEC v. AT&T headed to trial—is Reg FD constitutional?

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.  

Raiding the cookie jar—“part of the art of the close”?

In this Order, the SEC brought settled charges against Rollins, Inc., a termite and pest control company—think “Orkin”—and its former CFO for earnings management.  In essence, the SEC alleged that the company adjusted the amounts in several of its corporate reserves, without support or documentation, to bump up its EPS so that its EPS would meet analysts’ consensus EPS estimates for two quarters.  The company would otherwise have missed those consensus estimates by a penny in each quarter. The SEC charged the company with securities fraud under the Securities Act, financial reporting violations under the Exchange Act and failure to maintain adequate internal accounting controls and imposed a civil penalty of $8 million. The CFO was also charged with similar violations and ordered to pay a civil penalty of $100,000.  According to Gurbir Grewal, Director of Enforcement, “[t]his is the fourth action and the highest penalty to date against an issuer in connection with the Division of Enforcement’s highly successful and continuing EPS Initiative, which uses data analytics to uncover hard-to-detect accounting and disclosure violations by public companies….The SEC staff’s ever-increasing sophistication with data made today’s action possible and underscores that we will continue to pursue public companies that lack adequate accounting controls and engage in improper earnings management practices.”

Company charged for improper intra-company foreign exchange transactions

On Tuesday, the SEC announced settled charges against Baxter International Inc., its former Treasurer and Assistant Treasurer, for misconduct related to improper intra-company foreign exchange transactions that resulted in the misstatement of the company’s net income. From at least 1995 to 2019, the SEC alleged, Baxter converted foreign-currency-denominated transactions and assets and liabilities on its financial statements using its own “convention”—not in accordance with U.S. GAAP. Then, beginning around 2009, the SEC charged, Baxter leveraged the convention to devise a series of non-operating intra-company foreign exchange transactions “for the sole purpose of generating foreign exchange accounting gains or avoiding foreign exchange accounting losses.” In the order against Baxter, the SEC found that the company violated the negligence-based anti-fraud, public reporting, books and records, and internal accounting controls provisions of the federal securities laws and imposed an $18 million penalty. In this order and this order, the SEC found that the company’s Treasurer “did not take any steps to investigate how Baxter’s treasury department generated consistent gains or whether the transactions that generated the gains were permissible,” and that the Assistant Treasurer, working with others at his direction, was “primarily responsible for executing the transactions.” The Treasurer and Assistant Treasurer were determined to have violated the negligence-based anti-fraud provisions of the federal securities laws and to have caused Baxter’s public reporting and books and records violations.

SEC’s “shadow trading” case survives motion to dismiss

In August last year, the SEC announced that it had filed a complaint in the U.S. District Court charging Matthew Panuwat, a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company.  But this isn’t your run-of-the-mill insider trading case. Panuwat didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction.  No, according to the SEC, he engaged in what has been referred to as “shadow trading”; he used the information about his employer’s acquisition to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claimed was comparable to Medivation.  According to the SEC, Panuwat made that purchase based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. Incyte’s stock price increased after the sale of Medivation was announced.  The SEC charged that Panuwat committed fraud against Medivation in connection with the purchase or sale of securities, with scienter, in violation of Rule 10b-5; he had, the SEC charged, breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement. The SEC sought an injunction and civil penalties. (See this PubCo post.) In November, Panuwat filed a motion to dismiss the complaint under Rule 12(b)(6), calling it “an unprecedented expansion” of the Exchange Act. Last week, the Court denied the motion.