Early Takeaways From SEC's FY 2020 Fraud Enforcement

By Lou Mejia, Allison Handy and Stewart Landefeld 
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Law360 (October 9, 2020, 4:24 PM EDT) --
Lou Mejia
Lou Mejia
Allison Handy
Allison Handy
Stewart Landefeld
Stewart Landefeld
After a positive year of financial fraud enforcement in fiscal year 2019,[1] the U.S. Securities and Exchange Commission's Division of Enforcement posted quality cases in fiscal year 2020.

The SEC demonstrated its commitment to individual accountability, filing several cases against defendants from the C-suite. Its cases covered a variety of issues, including the misuse of reserves, revenue recognition, and disclosure malfeasance. The SEC also continued its use of data analytics to unearth improper conduct. Recognizing entities may seek to take advantage of the COVID-19 crisis to engage in fraud, the SEC has actively engaged in enforcement efforts in this area.

The SEC has not yet released information on the quantity of actions filed in fiscal year 2020, and we expect the release of that data in early November. However, because the books closed on the SEC's fiscal year on Sept. 30, we can now analyze and reach conclusions on the quality of financial fraud actions brought by the SEC. In this area, the SEC posted another successful year, bringing high-impact quality actions.

The Impact of COVID-19

In March, the SEC formed a steering committee to coordinate the Enforcement Division's response to coronavirus-related matters.[2] According to the SEC, stresses on the financial conditions of issuers relating to COVID-19 may expose preexisting accounting or disclosure improprieties, or lead issuers to engage in improper conduct.[3]

As Berkshire Hathaway Inc. Chair Warren Buffett more trenchantly observed, "After all, you only find out who is swimming naked when the tide goes out."

The SEC began to review public filings from issuers in highly impacted industries and to look for disclosures, impairments, or valuations that may attempt to disguise previously undisclosed problems as coronavirus-related.[4] In this fiscal year, the SEC first brought actions relating to COVID-19, including some against companies that allegedly falsely claimed to offer products to combat the virus.[5]

In March and June of this year, the SEC's Division of Corporation Finance issued guidance providing its views on how companies should consider disclosing the impact of COVID-19 on their operations, liquidity and capital resources during the pandemic.[6]

While the SEC respects the challenges that make it difficult to assess or predict precisely the effects of the pandemic, it expects managers to explain their views of the pandemic's future impact and how management is planning for COVID-19-related uncertainties. In seeking to address trends and uncertainties in management's discussion and analysis, it is important to provide a quality assessment from management's point of view, without boilerplate disclosures.

Where There's Smoke, There's Fire

Unless you work at a fire department, the words "smoke" and "fire" probably don't belong in internal emails. In a case against four former executives relating to an alleged scheme to defraud, an executive described the scheme internally as throwing "smoke bombs."[7] In this action, Outcome Health charged pharmaceutical companies to display ads in doctors' offices.

The SEC alleged the executives were aware of or engaged in a scheme to bill clients and recognize revenue for ads the company never ran. According to one executive, clients could not see behind the "smoke" and the company would get everything cleaned up before the smoke dissipated.

Smoke also can lead to fire. Those who ignore fire are sometimes equated to the Roman emperor Nero, who supposedly played the fiddle while Rome burned. Although the violin would not be invented until 1400 years after Nero's death, the phrase lives on, as shown in an SEC action against South Carolina Electric & Gas Co., SCANA Corp. and two former top executives.[8]

The SEC alleged the defendants made false and misleading statements that a nuclear power project was on track while knowing it was far behind schedule. One executive said the officers of the company "played our fiddles" while the project itself "was going up in flames."

Holding Senior Executives Accountable

The SEC continues to make individual accountability a priority, in many cases charging those at the top of the corporate hierarchy. The SEC charged CEOs in eight cases and chief financial officers in nine cases.[9] In many cases the SEC alleged the executives engaged in fraud. The conduct in three cases was so egregious that the U.S. Department of Justice, in a parallel action, charged executives with federal crimes.[10]

The Use of Data Analytics Pays Off

In the last week of the fiscal year, the SEC brought its first actions arising from the Enforcement Division's Earnings Per Share Initiative, which uses risk-based data analytics to uncover potential accounting and disclosure violations. In both cases, the SEC alleged companies made improper accounting adjustments to meet analyst consensus earnings per share estimates.[11] The initiative is the latest example of the increased use of data analytics by the Enforcement Division to identify potential securities law violations.

The Misuse of Reserves

Setting reserves for loss contingencies is complex and in part subjective, making it a tempting area to exploit for a company seeking to misrepresent its finances, particularly an insurance company. For insurance companies, the integrity of the reserve process is particularly important, as insurers require a rigorous actuarial process for estimating loss reserves.

In a case brought against AmTrust Financial Services and its former CFO, the SEC alleged the defendants failed to disclose material facts about how the company estimated its insurance losses and reserves. The SEC alleged the CFO made consolidated accounting adjustments in a manner that diverged from the company's disclosed actuarial process for estimating loss reserves.

The SEC further alleged the company failed to disclose and sufficiently document the specific method supporting the CFO's adjustments. The company and the CFO agreed to pay a combined $10.5 million to settle the action.[12]

In another case, the SEC charged MetLife Inc. with nonfraud violations of the securities laws for internal controls failures relating to two errors in its accounting for reserves associated with its annuities business. MetLife agreed to pay a civil penalty of $10 million to resolve the matter.[13]

Disclosure of Known Trends and Uncertainties

SEC regulations require public companies to disclose known trends and uncertainties that relate to its financial condition. Given that death is one of life's few certainties, you would expect that a funeral business could properly identify and disclose known trends and uncertainties.

That was not the case, according to the SEC, in its action against StoneMor Partners LP, an owner of cemeteries and funeral homes. The general partner identified material issues concerning two primary sources of cash flow. However, StoneMor's SEC filings did not include a discussion of material unfavorable trends and uncertainties concerning these two areas. As a result, investors were unable to fully assess StoneMor's liquidity.[14]

In another action, the SEC charged Diageo PLC, the international distiller and brewer for brands from Johnnie Walker to Guinness, for failing to make required disclosures of known trends relating to the shipments of unneeded products to distributors. The SEC alleged Diageo engaged in channel stuffing or "overshipping" on a continuous basis, by pressuring distributors to buy products in excess of demand in order to meet internal sales targets.

Diageo allegedly failed to make required disclosures of known trends and uncertainties resulting from this sales practice, leaving investors with a misleading impression of Diageo's true sales growth.[15]

Exercise Care With Perks

The SEC is currently conducting a review of several companies relating to perquisite disclosure. As part of the review, the SEC filed settled charges against Argo Group International Holdings Ltd. for failing to disclose over $5.3 million in perquisites provided to its former CEO. The SEC alleged that the perks Argo paid for — but did not disclose — included personal use of corporate aircraft, housing costs, transportation for family members, personal services, club memberships and tickets to entertainment events.[16]

Continued Focus on Revenue Recognition

The improper use of sales to distributors has been a frequent method of unlawful revenue recognition. This practice continued in the recent fiscal year as seen in the SEC's action against biotech company MiMedx Group Inc. The SEC alleged that MiMedx prematurely recognized revenue from sales to distributors and exaggerated revenue growth.

The SEC alleged the company's former CEO and former COO entered into undisclosed side arrangements with distributors that made the recognition of revenue at shipment improper.[17] In an action against Revolution Lighting Technologies Inc. and four senior executives, the SEC alleged defendants pressured personnel to improperly record anticipated future sales as current "bill and hold" sales to make up for revenue shortfalls.[18]

in another action, the SEC alleged a company's efforts to maximize end-of-quarter revenue were improperly aggressive, including the shipment of products without customer authorization.[19]

Other actions involved schemes by companies to create fictitious revenue. One company negotiated with a joint venture partner to artificially inflate the price it would pay for the company's IP assets while secretly agreeing to give back the amount of overpayment at a later date.[20]

In another action, a trucking company sought to conceal losses by engaging in a scheme to buy and sell trucks at inflated prices, in some cases double or triple their fair market value.[21]

In an action against three former executives of Ironclad Performance Wear Corp., the SEC alleged the executives inflated the company's revenues by, among other things, "booking nearly $1 million in revenues from a single client for gloves the client never bought, and that Ironclad never shipped."[22]

Useful Guidance on Cooperation Credit

The SEC has continued to highlight in settlement orders instances of cooperation by companies in investigations. In a positive development, the SEC is laying out more clearly its expectations about the level of cooperation and remediation that the SEC considers worthy of credit.

For example, in a settled action against Vereit Inc., the SEC described several cooperative and remedial steps taken by the company.

The company promptly self-reported to the SEC and disclosed to investors the preliminary results of an audit committee investigation in a Form 8-K. The audit committee continued its investigation thereafter and provided timely updates to the SEC. The company voluntarily produced documents and made its employees available for interviews with the SEC. The company also promptly undertook a series of remedial measures, including reforming policies, procedures, and controls, and instituting enhanced training. The company replaced its senior management team and its board of directors.

While all these steps may not be necessary for every company under SEC scrutiny, the SEC's description of cooperation and remedial steps in Vereit provides a menu of options for companies to consider.[23]


In a year in which the SEC has worked under difficult circumstances, the SEC continued to bring quality cases into the financial fraud space.

Lou Mejia is a partner at Perkins Coie LLP. He was previously chief litigation counsel at the SEC.

Allison Handy and Stewart Landefeld are partners at Perkins Coie.

Perkins Coie associate Anna Joy contributed to this article.

Disclosure: One of the parties mentioned, Diageo, is a client of the firm. However, the firm did not represent the company in the matter referenced in the article.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] SEC's Fraud Enforcement Shows Quality, If Not Quantity, Law360, October 31, 2019.

[2] Steven Peikin, Co-Director, Securities and Exchange Comm'n Division of Enforcement, Keynote Address: Securities Enforcement Forum West 2020 (May 12, 2020).

[3] Id.

[4] Id.

[5] SEC v. Praxsyn Corporation, (S.D. Fla., filed April 28, 2020); SEC v. Turbo Global Partners, (M.D. Fla., filed May 14, 2020); SEC v. Applied Biosciences Corp., (S.D.N.Y., filed May 14, 2020); SEC v. Schena, (N.D. Cal., filed Sept. 25, 2020).

[6] Securities and Exchange Comm'n Division of Corporation Finance Disclosure Guidance: Topic No. 9 (March 25, 2020); Securities and Exchange Comm'n Division of Corporation Finance Disclosure Guidance: Topic No. 9A (June 23, 2020).

[7] SEC v. Shah, et al., (N.D. Ill., filed Nov. 25, 2019).

[8] SEC v. SCANA Corporation, (D.S.C., filed Feb. 27, 2020).

[9] SEC v. Shah, (N.D. Ill., filed Nov. 25, 2019) (charging CEO and CFO); SEC v. SCANA Corporation, (D.S.C., filed Feb. 27, 2020) (charging CEO); SEC v. MiMedx Group, Inc., (S.D.N.Y., filed Nov. 26, 2019) (charging CEO, COO, and CFO); SEC v. Cole, (S.D.N.Y., filed Dec. 5, 2019) (charging CEO and COO); In the Matter of J. Michael Pearson , (filed July 31, 2020) (charging CEO); SEC v. Cordes, (N.D. Tex., filed April 8, 2020) (charging CEO and CFO); SEC v. Meek, (S.D. Ind., filed Dec. 5, 2019) (charging president/COO and CFO); SEC v. Amtrust Financial Services, Inc., (S.D.N.Y., filed June 17, 2020) (charging CFO); In the Matter of Howard Hideshima , (filed Aug. 25, 2020) (charging CFO); In the Matter of Charles Liang (filed Aug. 25, 2020) (charging CEO); SEC v. Revolution Lighting Technologies, Inc., et al., (D. Conn., filed Sept. 24, 2020) (charging CEO, CFO, and two CFOs of division).

[10] SEC v. Shah, (N.D. Ill., filed Nov. 25, 2019); SEC v. Cole, (S.D.N.Y., filed Dec. 5, 2019); SEC v. Meek, (S.D. Ind., filed Dec. 5, 2019).

[11] In the Matter of Fulton Financial Corp. , AP File No. 3-20084 (Sept. 28, 2020); In the Matter of Interface, Inc., et al., AP File No. 3-20085 (Sept. 28, 2020).

[12] SEC v. Amtrust Financial Services, Inc., (S.D.N.Y., filed June 17, 2020).

[13] In the Matter of MetLife, Inc. , (Dec. 18, 2019).

[14] In the Matter of StoneMor Partners L.P. , AP File No. 3-19616 (Dec. 12, 2019).

[15] In the Matter of Diageo plc , AP File No. 3-19701 (Feb. 19, 2020).

[16] In the Matter of Argo Group International Holdings, Ltd. , AP File No. 3-19822 (June 4, 2020).

[17] SEC v. MiMedx Group, Inc., (S.D.N.Y., filed Nov. 26, 2019).

[18] SEC v. Revolution Lighting Technologies, Inc., et al., (D. Conn., filed Sept. 24, 2020). The SEC alleged similar misconduct in In the Matter of Power Solutions International, Inc., AP File No. 3-20062 (Sept. 24, 2020).

[19] In the Matter of Super Micro Computer, Inc., AP File No. 3-19927 (Aug. 25, 2020).

[20] SEC v. Cole, (S.D.N.Y., filed Dec. 5, 2019).

[21] SEC v. Meek, (S.D. Ind., filed Dec. 5, 2019).

[22] SEC v. Cordes, (N.D. Tex., filed April 8, 2020).

[23] In the Matter of VEREIT, Inc. , AP File No. 3-19831 (June 23, 2020).

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