Worried the SEC might come after you personally? You should be

A disclosure and accounting fraud case brought this month by the Securities and Exchange Commission against a company and its general counsel and chief compliance officer provides yet more lessons about the sort of conduct that could potentially lead to a personal liability claim. The case is an important one for all companies that conduct internal investigations.

As regulators and enforcement authorities continue to expand the targets of their investigations beyond companies to the individuals who lead them, general counsels and chief compliance officers are increasingly finding themselves under scrutiny as a result of their reporting and disclosure obligations—or lack thereof.

At issue here is a case, SEC v. RPM International and Edward Moore, filed Sept. 9 by the SEC in the U.S. District Court for the District of Columbia against chemical company RPM International and Edward Moore, RPM’s general counsel and chief compliance officer. According to the SEC, RPM violated accounting principles and securities laws when it failed to disclose in a timely manner a material loss contingency arising from a Department of Justice investigation that ultimately resulted in a $61 million False Claims Act settlement in 2013.

The underlying dispute began in 2010, when a former employee of RPM’s subsidiary, Tremco, filed a sealed whistleblower complaint alleging that the construction products and services maker filed false claims in connection with two multiple award schedule contracts with the General Services Administration for roofing supplies and services. According to the Justice Department, Tremco failed to provide the government with the same price discounts that it provided to non-federal government customers.

At the time, Moore, who oversaw RPM’s response to the Justice Department investigation, failed to disclose material facts to RPM’s chief executive officer, the audit committee, and its independent audit firm, according to the SEC’s civil complaint.

Specifically, the SEC argues that Moore knew but failed to disclose that:

RPM sent the Justice Department several analyses estimating that Tremco overcharged the government by at least $11 million on the contracts;

RPM agreed to submit a settlement offer by a specific date to resolve the investigation; and

Prior to submitting the settlement offer, RPM’s overcharge estimates increased substantially to at least $27 million.

As a result of Moore’s misstatements and his failure to disclose material facts regarding the investigation, the SEC said, RPM submitted “multiple materially false and misleading filings” from October 2012 through December 2013. In August 2014, RPM restated its financial results for the first, second, and third quarters of fiscal year 2013.

As part of the complaint, the SEC further argued that Moore’s decision not to disclose the Justice Department investigation, or record an accrual, was motivated by personal gain. “Moore had a personal interest in RPM’s stock price because, as of August 31, 2012, he owned 65,952 shares of RPM stock—worth more than $1.8 million—plus 65,000 RPM stock options,” the complaint alleged.

“[T]he allegations mischaracterize both the company’s and Mr. Moore’s actions in connection with the matters related to the company’s quarterly results in fiscal 2013 and are without merit.”
Frank Sullivan, Chief Executive Officer, RPM International

The SEC is seeking permanent and injunctive relief against both RPM and Moore specifically to pay disgorgement with prejudgment interest and civil money penalties.

RPM Chairman and Chief Executive Officer Frank Sullivan has hotly fired back at the SEC’s allegations. “The restatements had no impact on the audited results for the fiscal year ended May 31, 2013, and the company’s audit committee concluded that there was no intentional misconduct on the part of any of its officers,” Sullivan said in a statement.

“[T]he allegations mischaracterize both the company’s and Mr. Moore’s actions in connection with the matters related to the company’s quarterly results in fiscal 2013 and are without merit,” Sullivan added. “The RPM board of directors has the utmost confidence in Mr. Moore’s integrity and ability and believe he conducted himself in this matter professionally, honestly, and ethically, consistent with his outstanding reputation earned over a distinguished legal career spanning more than 30 years.”

Sullivan added that Moore will remain in his current position and that RPM “will contest the allegations in the complaint vigorously and is confident it will prevail at trial.”

Broadening expectations

The unique circumstances of the case against RPM and Moore is worth watching, in part because it is one of just a handful of personal liability cases brought against a general counsel. Beyond that, however, the case is instructive as to how the SEC expects companies to handle the disclosure of an internal investigation.

SEC v. RPM INTERNATIONAL

Below is an excerpt from the case, SEC v. RPM International.
Defendant Edward W. Moore, RPM’s general counsel and chief compliance officer, oversaw RPM’s response to the DOJ investigation, but failed to disclose material facts about the investigation to RPM’s chief executive officer, chief financial officer, audit committee, and independent auditors For example, Moore knew but failed to inform them: (1) that RPM sent DOJ several analyses estimating that Tremco overcharged the government by at least $11.9 million on the contracts under investigation; (2) that RPM agreed to submit a settlement offer by a specific date to resolve the DOJ investigation; and (3) that, prior to submitting the settlement offer, RPM’s overcharge estimates increased substantially to at least $27-28 million. Additionally, Moore made material misrepresentations to the Audit Firm about the DOJ investigation in connection with the Audit Firm’s reviews and audits of RPM’s financial statements and SEC filings.
As a result of Moore’s misstatements and his failure to disclose key facts regarding the DOJ Investigation, from October 2012 through December 2013 RPM submitted multiple materially false and misleading filings to the SEC. For example, RPM’s SEC filings from October 2012 through January 2013 failed to disclose any information about the DOJ investigation, including any loss contingency or accrual on RPM’s financial statements, as required by the governing accounting principles and securities laws. Those filings also did not disclose any material weakness in RPM’s internal controls over financial reporting or its disclosure controls when in fact such weakness existed.
Source: SEC v. RPM International

Failure to disclose material loss contingencies could potentially result in personal liability, even in the absence of intent. “The fundamental lesson to individual lawyers and compliance personnel is to make sure the lines of communication are open to the audit committee and to the other chief officers of the firm, that a mistake like this is not attributable to a single person’s failure,” says Stephen Ascher, co-chair of the firm’s securities litigation and enforcement practice at law firm Jenner & Block.

From the company’s perspective, the flip side is true, Ascher says. The company must be communicative and ensure that it is asking the right questions.

For in-house counsel, in particular, the case serves as a stern warning on how quickly and easily the line between a general counsel’s legal responsibilities and business responsibilities can blur. During an internal investigation, in-house counsel typically receives significant amounts of communication that would otherwise be protected by attorney-client privilege. Once the general counsel faces a civil claim for misconduct involving the company, however, that general counsel is “ethically and legally entitled to reveal otherwise privileged information,” notes Marvin Pickholz, a partner in the securities and white-collar practice groups at law firm Duane Morris.

“If you’re a general counsel, you have a responsibility to that legal entity, which really means you have a responsibility to the shareholders to protect their assets.” Pickholz says. Similarly, he says, “you have a responsibility to report truthfully and honestly to the board and not hold back information.”

The case also offers lessons about the importance of coordination between counsel during an investigation—in this case, coordination between counsel handling the investigation and securities-disclosure counsel. According to the SEC, shortly after learning of the Justice Department’s investigation in 2011, RPM retained counsel to represent it in connection with the investigation, which “did not act as RPM’s securities disclosure counsel for SEC filings; instead, a different law firm served as RPM’s disclosure counsel.”

The complaint stops short of describing how either counsel advised Moore, or what information RPM or Moore provided to its securities-disclosure counsel. The lesson, however, is that “if there are breakdowns in communication, as there may have been here, the SEC and other regulators might be interested in exploring that,” says Joshua Newville, former senior counsel in the SEC’s Division of Enforcement, and now a partner at law firm Proskauer.

The case is also notable because it’s one of many in a growing list of cases the SEC has pursued under anti-fraud provisions of federal securities laws that merely require a showing of negligence, as opposed to the more difficult burden of showing scienter—a knowing intent to commit wrongdoing. Among the charges include violations of Sections 17(a)(2) and (a)(3) of the Securities Act, which prohibit fraud in the offer or sale of securities. “We expect the SEC to continue to bring cases alleging violations of negligence-based standards,” Newville says.

Despite the lower burden of proof, the resulting sanctions for the company can be just as serious as a criminal complaint. In this case, the SEC is seeking permanent injunctions, disgorgement of ill-gotten gains plus interest, and penalties.

For other companies conducting an internal investigation, it will be important to keep in mind that the SEC and the Justice Department often share communication and may cross-reference disclosures to catch discrepancies in disclosures—or non-disclosures, as the case may be. So it’s also vital, as indicated by the SEC, that in-house counsel leading an investigation be upfront about any material loss contingencies and that separate counsel closely coordinate with one another about their decisions throughout the course of the investigation.