My first thought was that it could be an April Fools joke . . . but no, that’s not the SEC’s style. I was reading about the SEC’s newest enforcement complaint alleging violations of the perquisite disclosure requirements in Item 402 of Regulation S-K, SEC v. Miller, No. 15-cv-1461 (N.D. Cal. Filed Mar. 31, 2015). On second thought, I knew this was no joke – it made sense that the SEC enforcement staff was continuing the unfortunate habit of bringing minor cases and overcharging them as supposed frauds of the century, setting themselves up for another litigation embarrassment, and, more importantly, misallocating enforcement resources and wasting taxpayer funds. The complaint is attached: SEC v. Miller Complaint. The joke is on the American taxpayers and Polycom shareholders.
This is another in a line of SEC cases for an alleged failure to disclose executive perquisites as “other compensation” in the company’s annual proxy statement. The SEC has had a bee in its bonnet for years about making sure that trivial amounts of money paid to executives be properly disclosed. I get the idea that large expenses for the personal use of company jets or yachts, or even multimillion dollar company-owned luxury apartments, might be interesting (or, more accurately, titillating) to shareholders, although rarely “material” in any true investment sense. If the SEC limited its perks enforcement activities to gross failures of that nature, I guess it would not be a total waste of taxpayer money. But outrageous undisclosed perks are few and far between nowadays, so the SEC enforcement staff gets itself in high dudgeon over trivial amounts of undisclosed company-paid personal expenses. Why? If the SEC staff were focused on maintaining fair and efficient securities markets it would be inexplicable. But many of them are not. Many of the enforcement staff specialize in being self-righteously judgmental, and they’ll be damned if rich, pampered, company executives avoid punishment for failing to disclose that the company paid for them to take friends, wives, or (perish the thought) “girlfriends” to the theater. That would be fine if the SEC staffers were spending their own money to satisfy their personal piques. But they are spending taxpayer money – and a lot of it – to pursue such trivial matters.
If you thing I’m going overboard, check out SEC v. Miller. The SEC is “making a federal case” out of the failure of Polycom, Inc. to disclose in its proxy statement that its former CEO, Andrew Miller, used Polycom money to fund personal expenses to the tune of “at least $190,000” over four years. I’m not missing any commas there; the crux of the case is the following allegation: “as Miller knew, Polycom omitted from its compensation disclosures at least the following amounts of Miller’s personal expenses, by fiscal year: approximately $15,435 in 2010; approximately $28,478 in 2011; approximately $115,683 in 2012; and approximately $30,474 in 2013.” This, per the agency that ignored red flags evidencing the huge Madoff and Stanford Ponzi schemes without ever being held accountable, constitutes “a long-running scheme to surreptitiously use Polycom funds to pay for his personal expenses, including lavish meals, foreign and domestic travel, clothing, gifts and entertainment for himself, and his relatives and friends.”
So, let’s see how terrible it really was. In 2010, the SEC alleges $15,435 in personal expenses were not disclosed as perquisites. In that year what was disclosed was “$4,341,868 in total compensation, including $111,493 in perks.” In 2011, the proxy allegedly failed to include $28,478 in perk disclosures, but did disclose “that Miller had received $5,016,646 in total compensation, including $112,998 in perks.” In 2012: “Polycom reported that Miller had received $7,356,905 in total compensation, including $31,430 in perks,” but allegedly failed to disclose $115,683 in perks. (That included two tickets to Les Miserables and Jersey Boys allegedly used by Miller and his “girlfriend.”) And in 2013, “Polycom reported that Miller had received $7,682,509 in total compensation, including $5,180 in perks,” but allegedly failed to disclose $30,474 in perks.
In other words, in the four years of this “long-running scheme,” Polycom allegedly failed to disclose roughly 0.3%, 0.6%, 0.4%, and 0.5% of Miller’s compensation. The alleged failure to disclose $190,000 in perks over four years compares to the actual disclosure of compensation to Mr. Miller totaling $24.4 million over that period. And corporate revenues during that period were roughly $5 billion. That represents the most the SEC could allege; the great likelihood is that if the evidence is ever presented, the actual shortfalls will be considerably lower, because the SEC enforcement staff generally doesn’t have a clue about when expenses are for business or non-business purposes. For example, the complaint goes on about a purported “personal” trip to Bali as part of a “CEO Circle” event, but I’ll bet you disclosure experts will agree that such events may be properly treated as business-related expenses, and not perquisites, because they are, under the SEC’s guidance, “integrally and directly related to the performance of the executive’s duties,” which include keeping the company’s most productive employees, and/or customers, happy campers. The SEC’s guidance makes it clear that how expensively those duties are performed has no bearing on whether they are perquisites, so whether the trip was to Bali or Fresno doesn’t matter for perquisite purposes. In any event, even in the unlikely event that the allegations are totally accurate, the SEC has already spent at least high six figures in taxpayer dollars to investigate and bring the case (and caused Polycom to foot the bill for more than that). If the case is tried, the SEC staff’s fixation on Mr. Miller’s peccadilloes will end up costing the taxpayers, and Polycom shareholders, millions more.
In fact, Polycom has already paid a hefty price – well more than the $190,000 supposedly taken from the company by Mr. Miller. For a bizarre reason, even though the SEC contends that Mr. Miller cheated the company, it brought an enforcement action against the company as well, which Polycom was forced to settle for $750,000. That is in addition to the legal fees incurred in the course of the SEC’s investigation, which probably means the SEC has already imposed costs on Polycom as much as 10 times greater than Mr. Miller’s allegedly improper expenses. Altogether now, the Polycom shareholders should join in: “Thank You, SEC, for protecting our interests.” See Polycom Inc. Agrees To Pay $750,000 To Settle SEC Civil Charge, and In the Matter of Polycom Settled SEC Administrative Action. This is Alice in Wonderland stuff.
But that is not the most outrageous thing about this case. The outrage is that the bad things the SEC is focused on are primarily matters of state law and corporate governance. What is alleged here is that the CEO of Polycom did some bad things. He spent some company money on things he shouldn’t have, and hid those things from the company, portraying them as legitimate business expenses. We can all agree those are bad things, but they don’t have much to do with the federal securities laws. They represent multiple breaches of fiduciary duty by the CEO to the company, and possibly outright theft, all of which is normally the focus of state law causes of action by the company (or possibly its shareholders if the company chooses not to act without good cause), or local law enforcement proceedings. Why is the SEC wasting resources on this kind of corporate trivia when there are real frauds going on out there — ones the SEC doesn’t find until shareholders are already under the bus? Instead, it is the SEC that is pushing the Polycom shareholders under the bus.
The federal securities laws are implicated only because SEC regulations mandate the disclosure of perks in the company’s annual proxy statement. So, you would expect the SEC to state causes of action against Mr. Miller for his alleged role in causing the company to file inaccurate proxy statements, and maybe for his alleged role in causing the company’s books and records to be inaccurate, because they purportedly included personal payments to the CEO as “business expenses” rather than compensation (although it is not at all clear that this would be a so-called “books and records” violation). There is no indication that the company failed to record these expenses on its books, in which case there would be no inaccuracy of even trivial amounts in Polycom’s financial statements. In short, the most appropriate SEC enforcement action would be one that charges violations of SEC rules by Mr. Miller, or that he caused Polycom to violate those rules. That would be sufficient to justify an embarrassing action against Mr. Miller accompanied by an injunction, a monetary penalty, and some form of disgorgement. And I’ll bet you the house that if that’s all the SEC staff proposed, there would now be a settled action that could minimize unnecessary taxpayer and shareholder expense.
But if the SEC enforcement staff stopped there, there would be no “securities fraud” charges, and the staff has this thing about wanting to charge people with “fraud” whenever they can, whether the evidence supports it or not. See SEC’s Single-Minded Focus on Fraud Theory Results in Loss on Appeal. As alleged, there was a “fraud,” but it was a fraud allegedly perpetrated by Mr. Miller against Polycom, by using deceit to get the company to pay for his personal expenses. That is not a “securities fraud,” and therefore is not an available color on the SEC’s enforcement palette. Only the company can pursue a claim that the CEO cheated it of some money. The only way the SEC can charge federal securities fraud – violations of section 10(b) of the Securities Exchange Act of 1934 or section 17(a)(1) of the Securities Act of 1933 – is if there was fraud in connection with a purchase, sale, or offering of securities. But scoring tickets for Les Miserables and Jersey Boys at company expense does not involve the purchase or sale of securities, even under the SEC’s broadest possible conception of what might be a security. The only securities involved here are Polycom stock or bonds.
That did not stop the SEC staff. They wanted a securities fraud charge, even if it required squeezing a square peg into a round hole. So, the SEC had to find a way to convert misstatements of CEO compensation by 0.3% to 0.6% into a fraud in connection with the purchase or sale of Polycom stock or bonds. No problem. The SEC does that sort of thing all the time by making unsupported allegations that alleged misstatements or omissions on even trivial matters were material to investors who purchased and sold Polycom securities. True to form, they allege in this complaint that the inaccurate perk disclosures were material to investors. (It’s impossible to tell if they maintained straight faces while concocting this theory.) Of course, the SEC litigators will never be able to prove that a reasonable investor could give a hoot that the compensation disclosures for the CEO were off by a fraction of a percent. But in the view of the SEC staff, if they contend something is material, it becomes material, regardless of whether investors care. In fact, although the Supreme Court precedent plainly states that materiality depends on whether information is important to a reasonable investor, the SEC regularly argues in court that any violation of an SEC disclosure mandate is material as a matter of law, because if the SEC requires it, it must be important to investors. QED.
Right now, there is a trial lawyer for the defense team licking his chops over the prospect of cross-examining an SEC expert trying to explain why a misstatement of an expense by 0.5%, and which represented, by my calculation, 0.004% of revenues, was material to a reasonable investor. If the judge does his job right, that potential testimony will not survive a Daubert motion.
To put icing on the cake, the SEC tries to stick it to Mr. Miller by alleging that when he sold Polycom shares during this period knowing that the perk disclosures for him were understated, he was engaging in securities fraud by trading stock while in possession of material nonpublic information, i.e., that compensation disclosures for him were understated by as much as 0.6%. That is a laughable theory; one can only hope that the district court judge will see it for the charade it is and dismiss that aspect of the case right out of the box. Historically, judges give the SEC the benefit of the doubt on fraud charges, dispensing with the usual requirements for pleading fraud under Rule 9(b) of the Federal Rules of Civil Procedure. But this contention is so far off the mark, and so incendiary if allowed to proceed (which was the point of making the allegation), that a decent judge should give it an early burial.
This is a case that any judicious law enforcement agency would have resolved with modest penalty and disgorgement payments, plus an injunction against future violations. The public airing of Mr. Miller’s hubris and poor judgment, if that’s what it was, would have shamed him, and made him damaged goods in the corporate executive marketplace. If what he did was actually theft from the company, let local law enforcement officials sort that out. That is how cases like this were resolved by more enlightened SEC enforcement lawyers in the heyday of perk cases many years ago. But in the ever-increasing ratcheting-up of punitive enforcement measures, the SEC is no-doubt looking for vastly overstated penalties, plus the return of profits from supposedly unlawful trading, topped off with a request that Mr. Miller be barred from ever serving in the future as an officer or director of a public company. Why not let fully informed boards of directors and shareholders decide for themselves in the future if his conduct warrants such a disqualification?
All of this, of course, forces Mr. Miller to defend his case to the hilt, pushing the SEC to present evidence of materiality and securities fraud it likely does not have. The table is set for another SEC enforcement loss on the fraud charges if this goes to trial. The last time the SEC took a case like this to trial it suffered a dismal loss. In November 2013, a jury ruled in favor of the defendant on all claims in SEC v. Kovzan, No. 2:11-cv-02017 (D. Kan. Filed Jan. 12, 2011), which was another perquisite case alleging trivial violations that lacked supporting evidence and made no sense as a matter of enforcement policy and an allocation of enforcement resources.
The main losers in SEC v. Miller will be “we, the people.” The taxpayers will pay for this exercise in overcharged macho enforcement, and, of course, the shareholders of Polycom will pay dearly as well, in amounts that dwarf the perquisite amounts alleged in the complaint. One way or another, through indemnity obligations or increased D&O insurance rates, Polycom will foot a mid-seven figure bill for defending claims that should never have been brought. The SEC will manage to make those seats to Les Miserables and Jersey Boys a lot more expensive than anyone could have imagined.
April 1, 2015
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