Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

We previously discussed an SEC enforcement action against Andeavor LLC for controls violations relating to a stock buyback plan it implemented while it was in discussion to be acquired by Marathon Petroleum Corp. in 2018. Andeavor agreed to pay a $20 million penalty to settle the charges.  According to the SEC order, the matter involved Andeavor’s failure to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that stock buyback transactions were executed in accordance with management’s authorization.  Andeavor did not admit or deny the findings in the SEC order.

Many were mystified as to why the enforcement action rested on an internal control violation and not an insider trading charge.

In a public statement SEC Commissioner Hester M. Peirce and Commissioner Elad L. Roisman explain their views on the enforcement action.

The two Commissioners note that the Commission’s order does not charge or find a violation of insider trading law under Rule 10b-5.  That would have required finding that Andeavor acted with scienter. However, Andeavor took steps to confirm that it did not possess material nonpublic information.

Since insider trading charges could not be proved, the Commission’s order found that Andeavor used an “abbreviated and informal process” to evaluate the materiality of the acquisition discussions, resulting in a “deficient understanding” of the facts and circumstances by its legal department.  On that basis, the Commission found that Andeavor failed to maintain an adequate system of internal accounting controls, in violation of Section 13(b)(2)(B).

Pierce and Roisman note that since Section 13(b)(2)(B)’s enactment in 1977, the Commission has never before found that the “internal accounting controls” required by that provision include management’s assessment of a company’s potential insider trading liability.

The pair of Commissioners take issue with casting Section 13(b)(2)(B) as a generic “internal controls” provision.  This provision requires not “internal controls” but “internal accounting controls.” Read in its statutory context, the required internal accounting controls seem primarily to concern the accounting for a public company’s assets and transactions to ensure that its financial statements are prepared in accordance with generally accepted accounting principles.  The purpose is to ensure that financial statements are accurate and reliable when disclosed to investors. It is not meant to address insider trading.

The two Commissioners are concerned that the Commission’s resolution of the case—if pursued to its logical conclusion in future cases—risks uprooting the core concept of “internal accounting controls” from the language, statutory context, and history of Section 13(b)(2)(B).  There may be temptation to simply view this provision as a generic “internal controls” requirement.

As for this case, the two Commissioners saw no evidence that Andeavor’s internal controls were inadequate with respect to the accounting for its repurchase transactions.  Andeavor’s Board of Directors authorized the company to spend $2 billion for share repurchases, and its CEO directed the company’s CFO to initiate the repurchase of $250 million of its shares over a period of several weeks.

The two Commissioners agree that Andeavor’s decision processes in this case left substantial room for improvement, and inadequate processes may expose a company to potential Rule 10b-5 liability. However the Commissioners doubt it is the SEC’s role under Section 13(b)(2)(B) to second-guess management’s decision processes on matters that do not directly implicate the accuracy of a company’s accounting and financial statements.

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