Yesterday, the SEC announced a settled action against Charter Communications for “violating internal accounting controls requirements when it engaged in stock buybacks not authorized by its board of directors.” More specifically, the Board had authorized the company to conduct stock buybacks using Rule 10b5-1 plans, but the SEC contended that Charter’s plans contained a provision that permitted too much discretion—allowing Charter to “change the total dollar amounts available to buy back stock and to change the timing of buybacks after the plans took effect.”  As a result, the SEC concluded, the plans did not satisfy Rule 10b5-1. But this was not a case about insider trading. Rather, the SEC charged, because the plans did not satisfy Rule 10b5-1, the buybacks were effectively unauthorized. And that was a problem of ineffective internal accounting controls (which, the SEC maintained, aren’t necessarily just about accounting). According to Melissa Hodgman, Associate Director of Enforcement, “[c]ompanies 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….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.” Charter agreed to pay a civil penalty of $25 million. Commissioners Hester Peirce and Mark Uyeda dissented.  

Background.  According to the Order, Charter, a broadband connectivity company and cable operator, has, since September 2016, repurchased over $70 billion of its own shares, reducing its outstanding shares by nearly 50%. As described by the SEC, these buybacks were authorized by the Board within certain financial limitations and other guidelines; for repurchases during Charter’s closed trading windows, the Board’s authorizations “were predicated on the company’s use of trading plans that conform to Rule 10b5-1.” However, the SEC alleged, from 2017 to 2021, Charter repurchased shares valued at almost $15 billion using trading plans that contained “accordion provisions,” provisions that gave the company discretion to increase its share repurchases in certain circumstances and thus did not conform to the requirements of Rule 10b5-1. According to the SEC, the Board did not authorize repurchases using non-Rule 10b5-1 plans. And there lies the problem.

As described in the Order, Charter’s trading plans included a “Plan Dollar Cap,” under which a pre-determined dollar amount was allocated to repurchase shares within certain set parameters and guidelines.  Charter conducted its buybacks using, in part, borrowed funds. As described by the SEC, Charter’s trading plans were “designed to ensure that Charter maintained a continuous buyback program while meeting the company’s publicly-disclosed leverage ratio target. “ To that end, in 2017, Charter began to use “accordion provisions” in its plans, a new funding mechanism that “allowed Charter to increase the Plan Dollar Cap if the company completed a debt offering in which a stated use of the proceeds from that offering included share repurchases.”  The “increase in the Plan Dollar Cap, which was tied to the amount of the new debt, allowed for additional share repurchases under the previously-set parameters and guidelines of the trading plans,” providing the company with the “flexibility to increase its share repurchases as new funds became available through debt closures.” But, as you know, “flexibility” and “10b5-1 plans” are not always compatible concepts.  The SEC alleged that Charter included accordion provisions in nine written trading plans between 2017 and 2021. According to the SEC, these trading plans with accordion provisions “did not satisfy the requirements of Rule 10b5-1.  Charter retained continuing discretion over whether and when to complete debt offerings and trigger the accordions.  Because the accordion provisions in these plans gave Charter the ability to change the total dollar amounts available for share repurchases, and the timing of additional repurchases, Charter’s plans did not meet the conditions of Rule 10b5-1(c)(1)(i)(B).”

But once again, from the SEC’s perspective, the charge here wasn’t directed at the allegedly defective 10b5-1 plans themselves—those would only have provided an affirmative defense in the event of allegations of insider trading if the plans had satisfied the Rule. And the SEC states that the additional repurchases were “under the previously-set parameters and guidelines.”  Rather, the problem was that Charter failed to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that its repurchases were executed and access to its assets was permitted only in accordance with the Board’s authorizations.  The Board’s authorizations for these buybacks were predicated on the company’s use of trading plans that comport with Rule 10b5-1.  Yet Charter did not have controls that reasonably assured that the company used trading plans in accordance with these authorizations.” 

The SEC charged that Charter should have implemented a “reasonable process to ensure that its trading plans were adequately reviewed for conformity with the requirements of Rule 10b5-1 prior to adoption.” Although Charter did have a number of controls around its share buybacks—controls to obtain Board authorization, to stay within the Board’s financial parameters and guidelines and to confirm that the buyback transactions were accurately reflected in its accounts and ledgers—nevertheless, the SEC charged, “Charter did not have reasonably designed policies or procedures for analyzing whether the accordion provisions comported with Rule 10b5-1” and thus were consistent with the authorizations. The failure of Charter’s controls to provide reasonable assurances was further evidenced, the SEC maintained, by Charter’s repeated use of trading plans with accordion provisions that did not conform with Rule 10b5-1.

Violations.  The SEC charged that Charter violated Exchange Act Section 13(b)(2)(B), which requires all reporting companies to “devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are executed and access to assets is permitted only in accordance with management’s general or specific authorization.”  It’s worth noting here that the Order goes on to explain (in a lengthy footnote with several citations) that internal accounting controls aren’t necessarily about accounting:  “the scope of Section 13(b)(2)(B) goes beyond the preparation of financial statements and broadly covers management authorizations for transactions.”  Charter agreed to pay a civil penalty of $25 million.

Dissent. Perhaps the Order’s explanation of Section 13(b)(2)(B) was in response to the dissent of Peirce and Uyeda. Comparing Rule Section 13(b)(2)(B) to a Swiss army knife—a “multi-use tool handy for compelling companies to adopt and adhere to policies and procedures that the Commission deems good corporate practice”—the two Commissioners contended that the SEC did “not have the authority to tell companies how to run themselves, but we now routinely use Section 13(b)(2)(B) to do just that.”

“The fundamental flaw in the Order,” according to the dissenters, was “its failure to distinguish between internal accounting controls and other types of internal controls.”  Section 13(b)(2)(B)(i) requires companies to maintain internal accounting controls.  But, they contended, the Order “recites no facts suggesting that Charter’s management used more funds than the board authorized for share buybacks, that management purchased shares at a quantity or time inconsistent with the board’s authorization, or that management failed to properly record the expenditure of corporate funds and consequent purchase of shares on Charter’s books.” Rather, the Order focuses on Charter’s failure to maintain controls to analyze its Rule 10b5-1 compliance. According to the dissenters, “[c]ontrols designed to answer a legal question—compliance with the regulatory conditions necessary to qualify for an affirmative defense—are simply not internal accounting controls within Section 13(b)(2)(B)’s scope.” As was the case with Andeavor LLC, an earlier action by the SEC regarding a Rule 10b5-1 plan and internal accounting controls—with which Peirce and former Commissioner Elad Roisman also took issue (See this PubCo post and this PubCo post)—the SEC here was attempting “to convert an internal accounting controls provision into an ever-unfolding utility tool that magically converts every corporate activity into something the Commission regulates are inappropriate extensions of the agency’s authority.”

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