Although it is not always appreciated or taken into account, the fact is that executives of private companies can be held liable for statements or other actions made in violation of the federal securities laws. One very recent and high-profile example where this happened involved the SEC enforcement action (and subsequent criminal proceedings) involving the high-profile medical testing company Theranos. Recent SEC and Department of Justice actions involving an Indiana-based company underscores the fact that private companies can draw the attention of federal securities regulator, and that it is not just high profile Silicon Valley firms that are potentially at risk.



As discussed in a SEC’s litigation release (here), on February 12, 2019, the agency filed a civil enforcement action in the Southern District of Indiana against two former executives of Evansville, Indiana-based plastics manufacturer Lucent Polymers, former CEO Kevin Kunash and former COO James Jimerson. A copy of the SEC’s complaint can be found here. According to the complaint, the company’s business of turning waste into high-quality plastics was highly successful, but the company’s business model was “a fraud.” The company and its executives allegedly routinely lied to customers and falsified its certification of testing data to create the impression that its products complied with customer criteria. Kunash and Jimerson continued to promote their company, including to investors, in order to try to facilitate the sale of the company, even after an internal whistleblower brought the fraud to their attention.


Kunash and Jimerson allegedly concealed the company’s fraudulent practices and made misrepresentations in connection with the sale of Lucent to Citadel Plastics Holdings. The SEC alleged that after the sale Kunash and Jimerson continued to conceal the fraud in order to obtain payments of the sale proceeds out of escrow and in order to help facilitate the sale of Citadel to a publicly traded company. As a result of these concealments, Kunash received payments of over $1.3 million and Jimerson received payments of over $600,000. After the sale of Citadel, the acquiring public company uncovered the fraud.


In its complaint, the SEC charges Kuhnash and Jimerson with fraud in violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and seeks permanent injunctions, disgorgement plus interest, civil monetary penalties, and officer-and-director bars.


In addition to the SEC’s enforcement action, on February 12, 2019 the U.S. Department of Justice announced that a grand jury had issued an indictment of Kunash and Jimerson in which the two were charged with conspiracy, fraud, and money laundering.  According to the DOJ’s press release, “The indictment alleges that they committed fraud when they orchestrated the sale of Lucent to another company but concealed critical defects in Lucent’s business, including fraud that Lucent was committing on its customers.”


The DOJ’s press release quotes an agency official as saying “Corporate officials who put deviousness over good faith degrade the integrity of our markets and impugn the reputation of American industry. This office will continue to prioritize the investigation and prosecution of corrupt corporate executives who enrich themselves through fraud and deception.” The DOJ statement says nothing about the fact that Lucent was a private company, nor in making its statements about the agency’s investigative priorities, the agency said nothing about differentiating between public and private companies.



As the Fenwick & West law firm noted in its February 22, 2019 memo about the SEC’s and the DOJ’s actions (here), “The government’s aggressive action here is a reminder that securities regulators and law enforcement agencies are increasingly scrutinizing statements made by private companies, especially statements that create investor fervor and lead to inflated share valuations.”


The SEC previously made it clear in its actions against Theranos that the agency would pursue alleged securities law violations even against private companies. But what is interesting to me about this latest action is that the SEC’s willingness to pursue private company executives for securities law violations is not limited just to high-flying high-profile Silicon Valley firms. The agency clearly is willing to go after even private companies in the heartland if it believes the violation warrants the action.


The law firm’s memo notes further that “the Lucent Polymers action in a broader sense demonstrates the SEC’s continued interest in ensuring that private companies have robust internal controls and governance procedures.” The law firm memo concludes by saying “Private companies should carefully analyze their procedures and controls for ensuring that their public representations and disclosures are accurate. Statements about a company’s key technology are especially important to potential investors, and consequently, those statements will also be scrutinized by government regulators.”


The SEC’s recent actions clearly have important risk management implications for private companies. It is critically important that companies and their executives – even just with respect to private companies – face potential liability exposure under the federal securities laws for alleged misrepresentations to prospective investors and others.


The potential exposure of private company executives under the federal securities laws has potentially important D&O insurance implications. The D&O community tends to divide the world between public and private companies and to proceed on the assumption that potential liability under the federal securities laws is strictly a concern for public companies. As this case highlights, this division between public and private companies when it comes to liabilities under the federal securities laws is not nearly as strict as the common presumption typically assumes.


This case shows that private company executives could face SEC enforcement action; any executive caught up in these kinds of proceedings would want to look to their company’s D&O insurance to provide their defense. However, whether or not the private company’s D&O insurance policy would respond will depend significantly on the policy’s actual wording, including, among other things, the wording of the policy’s securities exclusion. This exclusion is intended to preclude coverage under the private company policy for liabilities incurred in connection with taking the company public – the insurer did not undertake to insure a public company and so excludes public company liabilities under the policy.


The wordings of these exclusions vary widely, and in some versions the exclusion is written sufficiently broadly that the insurer might seek to rely on the exclusion to preclude coverage for the kinds of actions that were brought here against private company executives. Ideally, the exclusion would not even go into effect unless the insured company has completed a public offering; however, not all exclusions are so limited.


For that reason, it will be critically important for private company executives worried about the availability of policy coverage in the event of the kind of enforcement action brought against the executives here will want to review their policy with their insurance advisor to ensure that the exclusionary wording would not preclude coverage in the event of one of these kinds of claims.