United States: Commissioners Pierce And Roisman Dissent To Broad Interpretation Of Internal Accounting Controls
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On October 15, 2020, the US Securities and Exchange Commission
(SEC) issued a cease and desist order (Order), settling charges
against a registrant for controls violations relating to a stock
buyback plan implemented during acquisition discussions. The
company’s Board of Directors authorized stock repurchases in
compliance with a policy that prohibited the company from buying,
or entering into a Rule 10b5-1 plan to buy, its securities while it
was in possession of material non-public information.
According to the Order, the company failed to design and maintain
internal accounting controls sufficient to provide reasonable
assurance that the stock buyback during acquisition discussions
would be executed in accordance with its Board’s authorization.
The Order found this failure to be a violation of Section
13(b)(2)(B) of the Securities Exchange Act of 1934.
On November 13, 2020, SEC Commissioners Hester M. Pierce and
Elad L. Roisman issued a statement (Statement) explaining that they
voted against the SEC’s settlement because they believe the
SEC’s “finding entails an unduly broad view of Section
13(b)(2)(B).” Both Commissioners agree that insider trading by
public companies engaged in share repurchases is unacceptable and
they support vigorous enforcement securities laws against corporate
wrongdoers. In their view, however, applying Section 13(b)(2)(B) to
require “internal accounting controls” to include
management’s assessment of a company’s potential insider
trading liability exceeds what they interpret as the limited scope
of that statutory provision.
Commissioners Pierce and Roisman observe that Rule 10b-5
prohibits companies from repurchasing their stock while in
possession of material nonpublic information but note that Rule
10b-5 only prohibits misuse of such information with an intent to
defraud. While characterizing the decision processes for the
company’s repurchase as leaving “substantial room for
improvement,” Commissioners Pierce and Roisman point out that
the Order did not charge or find a violation of Rule 10b-5, which
would have required finding that the company acted with scienter
despite steps it took to confirm that it did not possess material
non-public information. The Statement describes facts that may have
precluded an intent to defraud analysis in this case.
In the Statement, Commissioners Pierce and Roisman emphasize
that Section 13(b)(2)(B) is not a generic “internal
controls” provision, but rather an “internal accounting controls” provision
with its central focus on accounting. They express concern
that the SEC is using Section 13(b)(2)(B) to widen the role of
internal accounting control to encompass policies that “go
well beyond the realm of ‘accounting controls,'” a
view which they assert no court has adopted. The Statement
expresses the position that it is inappropriate for Section
13(b)(2)(B) to be used “to second-guess management’s
decision processes on matters that do not directly implicate the
accuracy of a company’s accounting and financial
statements.”
The Statement is available
here.
The Order is available here.
Originally Published by Mayer Brown, November 2020
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