One frequently asked question is whether members of a corporate board’s audit committee face heightened liability exposures. Two recent SEC enforcement actions seem to underscore that audit committee chairs do face liability exposures. Though both cases involve somewhat unusual circumstances, they seem to suggest that the “gatekeepers” on which SEC has said it will be concentrating increased enforcement focus may include audit committee members.
Hat tip to Daniel Goelzer at the Baker & McKensie firm for his April 2014 memo entitled “Audit Committee and Auditor Oversight Update” (here) that brought these cases to my attention.
The Ag Feed Case: On March 11, 2014, the SEC filed an enforcement action in the Middle District of Tennessee against Agfeed Industries and certain of its current and former directors and officers. including K. Ivan Gothner, who served as chair of the company’s audit committee, and Edward Pazdro, who served for a time as the company’s CFO.
The SEC’s complaint, which can be found here, alleges that from 2008 through June 30, 2011, AgFeed, an animal nutrition and hog production company, overstated its revenue by $239 million. The fraud allegedly was orchestrated by the company’s Chinese management. The complaint alleges that in May 2011, Gothner and Pazdro learned that the hog production division had maintained two sets of books in China – a real set and a fake set. In June 2011, Gothner and Pazdro received a report from Chinese counsel at AgFeed which concluded based on witness statements and documents that AgFeed had maintained the two sets of books for the purpose of inflating revenue and profits, that the company’s former CEO and CEO had directed the fraud, and that the former CFO had ordered the destruction of the second set of books.
The complaint alleges that between June 2011 and September 2011, a period during which the company was engaged in an effort to raise capital, Gothner and Pazdro “engaged in a scheme to avoid or to delay disclosure of the fraud,” including failing to disclose the fraud to auditors and to key company personnel. With respect to Gothner, the audit committee chair, the SEC further alleges that he misrepresented to counsel that a third-party expert had been hired to analyze the USB stick on which the two sets of books were maintained when no expert had been hired. Both Gothner and Pazdro are alleged to have failed to “conduct further meaningful inquiries into the fraud even as additional red flags arose.” The complaint further alleges that their failure to act on the fraud allowed the company to file a false and misleading Form 10-Q in August 2011.
L&L Energy: On March 27, 2014, the SEC filed an administrative cease and desist order against Shirley Kiang, the firmer audit committee chair of L&L Energy, a Seattle-headquartered coal company with all of its operations in China. The order alleges that the company misrepresented in public filings that a person was serving as the company’s Acting Chief Financial officer when in fact that person never did.
The order alleges that in May 2009 while Kiang was audit committee chair, the purported Acting Chief Financial Office became aware that she had been falsely represented as the company’s Acting CFO, and that the purported Acting CFO asked Kiang to investigate. Kiang advised the company’s chairman of the information; the chairman told Kiang that the person had never actually served as the Acting CFO and that Kiang should not share this information with anyone, including the company’s Board of Directors or the public.
In August 2009, the company filed its 10-K for the 2009 fiscal year. The 10-K contained the required certifications that any fraud involving management had been disclosed to the company’s auditors and audit committee. The SEC cease and desist order alleges that when Kiang signed this certification, she knew or should have know it was false.
The SEC’s cease and desist order charges that by withholding the information that the purported Acting CFO had not served as the actual Acting CFO and allowing the false certifications to be filed, Kiang “caused” L&L Energy to violate the reporting requirements of the securities laws. Kiang agreed to settle with the SEC without admitting or denying allegations (because the cease and desist order was filed in an administrative proceeding, no judicial approval was required). Kiang consented to the entry of an order directing her to cease and desist from any future violations.
As the Baker McKenzie memo notes, enforcement actions against audit committee chairs are rare, and these two cases involving as they do somewhat unusual fact patterns “may seem of limited significance.” However, these two enforcement actions come at a time when the SEC has already announced its intention to pursue “gatekeepers” and to hold them accountable.
It is noteworthy in that regard that a March 11, 2014 Reuters article discussing the action against the AgFeed audit committee chair quotes SEC Enforcement Director Andrew Ceresney as saying that “today’s enforcement action is a cautionary tale about what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags.”
As the law firm memo puts it, “these cases seem to illustrate how the Commission intends to apply its gatekeepers program to audit committee members.” The Reuters article linked above quotes a leading defense attorney as saying that the AgFeed enforcement action represents “a warning shot across the bow” for public company audit committees,” and that the case is a reminder that “audit committees must follow up on red flags and seek outside counsel for assistance.”
At a minimum the cases should affect the way that audit committee members – particularly audit committee chairs – think about the liability exposure associated with their activities in those roles. These individuals will not only want to understand their exposures but also will want to inquire about the indemnification and insurance available to protect and defend them in the event they are hit with an action based on their service in those roles.
Special thanks to a loyal reader for sending me a copy of the Baker & McKenzie law firm memo.
The Beautiful Game: For many years, my wife and I have joked that when the Wall Street Journal or the New York Times decide to try to do some trend-spotting, they peek inside our house and then write about what we are doing. So it was this morning, when my wife handed me the Thursday Styles section of today’s Times, said, “They’re following us around again,” and pointed to an article entitled “Their Game, Now Ours,” (here), which in the print edition has the subtitle “Soccer emerges as the sport of the thinking class in the U.S.”
Regular readers undoubtedly are aware that I am an energetic fan of European soccer (sorry, to avoid confusion, I can’t call it football in this context), particularly English Premier League soccer. Some may even recall the short item in my post this past Monday about Liverpool’s dramatic 3-2 win over Manchester City on Sunday – a game that the Times article in fact references in its very first sentence. Among other things, the article states that soccer is a topic you can no longer ignore, which is “particularly evident in New York creative circles, where the game’s aesthetic, Europhilic allure and fashionable otherness have made soccer the new baseball – the go-to sport for the thinking class.”
I commend the Times article to anyone interesting in thinking about whether there actually is a trend here. For myself, I think the current enthusiasm for the sport has less to do with Europhilic sensibilities and more to do with the sheer pleasure of watching the matches. It is, as is often said, a beautiful game – in fact, the beautiful game.
If you have any doubts about the game’s beauty, I recommend you watch the video below of the welsh soccer star Gareth Bale of Real Madrid scoring what proved to be the winning goal in Wednesday’s championship match in the annual Copa del Rey soccer tournament, between Real Madrid and perennial rival Barcelona. It is one thing to watch the replay aware that you are about to see something special; at the time Bale scored the goal, the moment was absolutely electric. You will note in the video that when Bale’s breakaway run ended with his spectacular goal, Barcelona players collapsed onto the pitch as if they were literally thunderstruck. Watch this video, and you will see what the excitement is about. (When the video begins, hit Skip Ad, and don’t worry when the video freeses momentarily about 49 seconds in, it starts up again).