SEC Uses ‘Swiss Army’ Statute in $25 Million Fine for Violations on Stock Buybacks

Companies that alter their trading plans outside guidelines authorized by their boards should beware of the risk of heightened regulatory scrutiny from the Securities and Exchange Commission. The agency on November 14 announced that Charter Communications Inc. agreed to pay a $25 million penalty to settle claims the company violated internal accounting controls requirements regarding its share buyback plans. It’s a sign the SEC means business about cracking down on abuses of so-called 10b5-1 plans.

According to the SEC’s order, Charter’s board authorized certain buybacks using trading plans that comply with Rule 10b5-1, which offers protection to companies and individuals from insider trading liability as long as they meet the conditions of the rule. In particular, the rule requires that they do not change planned purchases or sales after the trading plan is adopted.

But the SEC contends that from 2017 to 2021, Charter used nine separate trading plans that included “accordion” provisions to give company personnel the flexibility to change the total dollar amounts available to buy back stock and to change the timing of buybacks after the plans took effect. As such, the SEC said Charter’s trading plans did not meet the conditions of Rule 10b5-1 and did not comport with the board’s authorizations.

The twist? The SEC characterized this not as an insider trading case, but instead as a case about insufficient internal accounting controls. Specifically, Charter’s use of 10b5-1 plans demonstrated the “absence of reasonably designed controls to analyze whether the discretion the accordion provisions gave executives to alter the company’s trading was consistent with the board’s authorizations,” according to the agency.

“Companies whose boards authorize buybacks using Rule 10b5-1 plans must have controls that reasonably assure that their trading plans meet all of the rule’s conditions,” said Melissa Hodgman, associate director in the SEC’s Division of Enforcement. “This includes the fundamental requirement that, to benefit from the protection of Rule 10b5-1, traders have to relinquish their ability to influence the amount or timing of trades after their trading plans go into effect.”

Unsurprisingly, two SEC commissioners who have objected to recent enforcement actions related to deficiencies in other types of company controls also took issue with the Charter case. GOP appointees Hester M. Peirce and Mark T. Uyeda in a November 14 statement railed against the Charter settlement. The dissenting duo said the SEC is using Section 13(b)(2)(B) as its “own Swiss Army statute — a multi-use tool handy for compelling companies to adopt and adhere to policies and procedures that the Commission deems good corporate practice.” (In case you’re unfamiliar with the allusion, Peirce and Uyeda included a history of the Swiss Army Knife in their statement.)

In the view of Peirce and Uyeda, the SEC is using the statute “to tell companies how to run themselves.” They added that the case is the “latest application of the unsupportable and ill-considered interpretation of Section 13(b)(2)(B) that the Commission advanced more than three years ago” in a  $20 million settlement with Andeavor, LLC.

In a November 16 summary of the Charter settlement, law firm Davis Polk warned that the SEC’s future enforcement approach might not be limited to buybacks. The firm’s analysis pointed to a footnote in the order that said the SEC “had always interpreted the provisions to apply to ‘corporate accountability’ more broadly.”

“Any scenario in which a company engages in transactions with corporate assets in a manner that does not fully comply with a particular board authorization could come under SEC scrutiny for potentially deficient internal accounting controls, especially if there is a linkage to conduct that a majority of SEC commissioners believes falls short of good corporate practice,” lawyers from Davis Polk wrote in the note.

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