Last week, the SEC announced several enforcement actions as it wrapped up its fiscal year; here’s John’s blog about an alleged MD&A “Known Trends” violation. Earlier though, another SEC enforcement settlement slipped under the radar, in which the SEC alleged that a Nasdaq-traded company in the business of “live-adult entertainment clubs” and “military-themed Bombshells restaurants” failed to disclose a variety of perks and related party transactions and that a former director failed to disclose personal bankruptcies.
With the mix of allegations, the action provides a good case study on disclosure controls & procedures, and the SEC Enforcement folks took care to lay out in striking tables the value of perks allegedly received by execs versus what the company had disclosed in its proxy statements, including a Valentine’s Day trip by the CEO’s girlfriend to meet him when he was away on business. The press release summarizes the actions, and the 11-page order provides more color:
From FY 2014 through FY 2019, RCI failed to disclose a total of $615,000 in executive compensation in the form of perquisites. According to the order, these undisclosed perquisites included the cost of the personal use of the company’s aircraft and company provided vehicles, reimbursement for personal airline flights, charitable corporate contributions to the school two of the CEO’s children attended, and housing costs and a meals allowance for the CFO. In addition, the order finds that RCI failed to disclose related party transactions involving the CEO’s father and brother and a director’s brother. The order further finds that RCI failed to keep books and records that allowed it to report, and lacked sufficient internal controls concerning, these executive perquisites and related party transactions.
The former director served on the company’s audit committee and had filed two personal federal bankruptcy petitions that he failed to disclose to the company. The order involving the former director states that he also served as the audit committee financial expert and that he didn’t disclose the bankruptcy filings due to embarrassment and he didn’t want to embarrass the company. Once the company learned of the bankruptcy filings, the company asked him to step down from the board.
Without admitting or denying the SEC’s findings, RCI, the CEO and CFO consented to a cease & desist order and agreed to pay civil penalties in the amounts of $400,000, $200,000, and $35,000, respectively. With regard to the former director, he also consented to a cease-and-desist order and to pay a $30,000 civil penalty. The former director further agreed to be suspended from appearing or practicing before the SEC as an accountant, with the right to apply for reinstatement after three years.
These cases provide a good synopsis of how important it is to have internal controls and checks & balances in place. The SEC’s order sheds light on RCI’s internal control issues. For instance, the company identified personal use of company aircraft as a tax issue by reporting income on the executives’ W-2 forms but then didn’t disclose the value of personal aircraft use in the company’s SEC filings. In another instance, the company didn’t properly account for the full value of automobile perquisites because the value disclosed only included depreciation amounts as incremental costs and didn’t include other costs such as fuel, maintenance, registration and insurance. And as this excerpt shows, the company took the inadvisable approach of relying on personal judgment when it came to reimbursement requests:
The company did not have internal controls or policies and procedures concerning expense reimbursement requests approvals because management never got down to that specific detail. In the absence of expense reimbursement controls, persons approving reimbursement requests would use their “judgment,” resulting in undisclosed compensation to officers.
As employees move into new roles or assume new responsibilities, it’s a good idea to periodically revisit internal controls and policies to make sure everyone is on the same page and correctly following procedures. To help, check out the 2021 Edition of Lynn & Borges’ “Executive Compensation Disclosure Treatise,” our checklists about travel & expense policies, resources available on CompensationStandards.com and our “Related Party Transactions Disclosure” handbook available on this site. And, questions about perks and related party transactions come up frequently on our Q&A forum and the CompensationStandards.com Q&A forum. You can search previous posts or post a question anonymously!
-Lynn Jokela, TheCorporateCounsel.net October 5, 2020
