The SEC has commenced an enforcement action against a private company and its former Chairman and CEO in connection with the company’s repurchase of company shares from company employees and others prior to the company’s acquisition.


The action involves Stiefel Laboratories, which prior to its April 2009 acquisition by GlaxoSmithKline for $68,000 a share, was, according to the SEC “the world’s largest private manufacturer of dermatology products.”  On December 12, 2011, the SEC filed a complaint (here) in the Southern District of Florida alleging that the company and Charles Stiefel, its former chairman and CEO, defrauded shareholders by buying back their stock at “severely undervalued prices” between November 2006 and April 2009. The SEC’s December 12, 2011 press release about the enforcement action can be found here.


The company had an Employee Stock Bonus Plan through  which employees gained ownership of company shares. The company also engaged in direct share transactions with other shareholders. Because the shares did not trade on public markets, company share purchases were essentially the only way for shareholders to liquidate their shares of company stock.


The price for company share purchases was set through an annual l third-party share valuation each March. The company relied on a third-party accountant to perform the valuation. However, the SEC alleges that the accountant “used a flawed methodology and was not qualified to perform the valuations.” In addition, the SEC alleges that that shareholders were not told that after the valuation process, the defendants “discounted the stock by an additional 35%.”


In addition, beginning in 2006, the company began a series of conversations that culminated in the April 2009 sale of the company to Glaxo Smith Klein. During the course of these various discussions, the defendants received a series of valuations that were significantly higher than the third party valuation used for share repurchase purposes. The company did not advise employees or the accountant who performed the annual share price valuation of these much higher valuations. In addition, the company not only did not inform the employees about the ongoing negotiations, but repeatedly indicated that the company would remain private.


While these discussions were going forward, the company continued to repurchase company shares at valuations that were significantly below both the valuations that the prospective company buyers were using and that were also well below the ultimate sale price of $68,000 per share. Thus between November 2006 and April 2007, the company purchases 750 company shares at $13,012 a share. Between June 2007 and June 2008, the company purchased more than 350 additional shares at $14,517 a share, and bought an additional 1,050 shares from shareholders outside the Plan at an even lower stock price. Between December 3, 2008 and April 1, 2009, the company purchased more than 800 shares of its stock from shareholders at $16,469 per share.


The SEC alleges that shareholders lost more than $110 million from selling their shares back to the company based on the misleading share valuations. The SEC alleges that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, by repurchasing the shares at undervalued prices and in reliance on undisclosed material information, including both the higher valuations and the possibility of the company’s sale. The SEC’s complaint seeks declaratory relief, permanent injunctive relief, an officer and director bar, disgorgement and civil penalties.



The allegations against the company and its former Chairman involve alleged misconduct that took place when the company was still a private company. I suspect that many readers will be surprised to learn that an SEC enforcement action against or in connection with the actions of a private company.


As explained in a January 10, 2012 memorandum from the Stites & Harbison law firm (here), Rule 10b-5 “prohibits, in connection with the purchase or sale of any security (public or private) making any untrue statement or omitting to state a material fact necessary in order to make the statements not misleading.” The allegations against the defendants here present a “cautionary tale for any private company,” underscoring the fact that federal and state securities laws govern even private company securities transactions and “restrict small closely held firms no differently than they restrict large, publicly-held corporations.” 


The law firm memo emphasizes that a private company in possession of material nonpublic information that is under a contractual obligation to consummate a transaction involving its own securities could face a dilemma — for example, a pending transaction may put the company in a position where it may neither disclose pending negotiation nor abstaining from repurchase obligations under stockholder or similar agreements. The memo’s authors observe that private companies should “thoughtfully scrutinize the structure of a transaction in its own securities and would be well served to tailor corporate policies to ensure compliance with securities law obligations.”


The SEC’s allegations here present a cautionary tale in another sense as well. Some private company D&O insurance policies may be procured or written based on the assumption that, because the company is privately held, the company and its directors and officers face no potential liability under the federal securities laws. Or at a minimum, D&O insurance policies may be structured with insufficient awareness about the possibility that even a private company potentially could fact liability under the federal securities laws. This case shows that a company and its officials can fact potential liability under the securities laws in connection with transactions involving the companies own securities, even if the company’s shares are not publicly traded.


Of particular concern here is the securities offering exclusion found in many private company D&O policies. The wordings of these exclusions vary widely. Depending on the wording used in any particular private company policy, the exclusion might potentially preclude coverage for the type of claim presented here. The best versions of these types of exclusions specify that they do not apply unless the company has conducted an initial public offering. But as this case highlights, a private company D&O policy could be called upon to respond to an action alleging a securities law violations; indeed, it could be called upon to respond to an SEC enforcement action even where, as here the company’s shares are not publicly traded and where there has been no IPO. There might ultimately be no coverage under the policy for amounts representing disgorgements or fines or penalties, but the question of whether or not there is coverage for defense expenses (which could be quite substantial) could well depend on the wording of the securities exclusion.


All of which means, at a minimum, that the wordings of the securities offering exclusion in private company D&O insurance policies need to be reviewed closely with an eye toward the possibility of claims of this type.


Don’t Be That Guy: According to a January 12, 2011 Wall Street Journal article (here), Alan Gilbert, the conductor of the New York Philharmonic, brought a performance of Mahler’s Ninth Symphony to a halt when the orchestra’s performance of the music piece’s final movement – a sonorous rumination on the meaning of mortality – was interrupted by a persistent cellphone ringtone the article described as having a xylophone sound with a marimba beat. The cellphone’s owner apparently was seated in the front row at the performance at Avery Fisher Hall. 


I suspect that the next time the cellphone owner is asked to turn off their cellphone, he or she will actually make sure the phone is powered down.