On October 15, 2020, the US Securities and Exchange Commission (SEC) issued a cease and desist order (Order), settling charges against a registrant for controls violations relating to a stock buyback plan implemented during acquisition discussions.  The company’s Board of Directors authorized stock repurchases in compliance with a policy that prohibited the company from buying, or entering into a Rule 10b5-1 plan to buy, its securities while it was in possession of material non-public information.  According to the Order, the company failed to design and maintain internal accounting controls sufficient to provide reasonable assurance that the stock buyback during acquisition discussions would be executed in accordance with its Board’s authorization.  The Order found this failure to be a violation of Section 13(b)(2)(B) of the Securities Exchange Act of 1934.

On November 13, 2020, SEC Commissioners Hester M. Pierce and Elad L. Roisman issued a statement (Statement) explaining that they voted against the SEC’s settlement because they believe the SEC’s “finding entails an unduly broad view of Section 13(b)(2)(B).” Both Commissioners agree that insider trading by public companies engaged in share repurchases is unacceptable and they support vigorous enforcement securities laws against corporate wrongdoers. In their view, however, applying Section 13(b)(2)(B) to require “internal accounting controls” to include management’s assessment of a company’s potential insider trading liability exceeds what they interpret as the limited scope of that statutory provision.

Commissioners Pierce and Roisman observe that Rule 10b-5 prohibits companies from repurchasing their stock while in possession of material nonpublic information but note that Rule 10b-5 only prohibits misuse of such information with an intent to defraud.  While characterizing the decision processes for the company’s repurchase as leaving “substantial room for improvement,” Commissioners Pierce and Roisman point out that the Order did not charge or find a violation of Rule 10b-5, which would have required finding that the company acted with scienter despite steps it took to confirm that it did not possess material non-public information. The Statement describes facts that may have precluded an intent to defraud analysis in this case.

In the Statement, Commissioners Pierce and Roisman emphasize that Section 13(b)(2)(B) is not a generic “internal controls” provision, but rather an “internal accounting controls” provision with its central focus on  accounting. They express concern that the SEC is using Section 13(b)(2)(B) to widen the role of internal accounting control to encompass policies that “go well beyond the realm of ‘accounting controls,’” a view which they assert no court has adopted. The Statement expresses the position that it is inappropriate  for Section 13(b)(2)(B) to be used “to second-guess management’s decision processes on matters that do not directly implicate the accuracy of a company’s accounting and financial statements.”

The Statement is available here.

The Order is available here.

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