SEC Charges Director With Primary Securities Law Violations for Failing to Take Steps to Ensure the Accuracy of Company Filings

Here's a case from the SEC to which corporate directors (and potentially other gatekeepers) should be alert. In SEC v Raval, the SEC charged Vasant H. Raval, the chair of the company's (InfoGroup) audit committee, with primary violations of the securities laws for failing to take steps to ensure the accuracy of the company's SEC filings despite significant red flags. SEC Complaint vs. Raval; Litigation Release.

The complaint alleges that, over a four-year period, the CEO used the company as a piggybank to support his lavish lifestyle by directing the company to pay him (the CEO), in the form of reimbursed business expenses, approximately $9.5 million of unauthorized and undisclosed perquisites, including payments for homes and the personal use of jets and yachts. Over the same period, the company entered into related-party transactions totaling approximately $9.3 million with entities controlled by or affiliated with the CEO, without disclosure in the company's SEC filings. The complaint further charges that Raval became aware of red flags about these matters, but "did not take appropriate action and, although he knew, or was reckless in not knowing, that the red flags had not been addressed," he reviewed and signed 10-Ks and solicited proxies. As a result, he was alleged to have violated the securities laws "directly and indirectly."

The complaint states that, as part of approving a new related-party transaction policy to comply with SOX, the audit committee reviewed a detailed list of related-party transactions, including related-party payments and payments related to homes and yachts involving the CEO. When the list was brought to the attention of the board, because it raised serious questions, the board determined that an investigation was necessary and tasked Raval, in his role as chair of the audit committee, to conduct the investigation and report back before the 10-K was due. The investigation revealed to Raval insufficient documentation and other internal control problems related to the reimbursements, but, according to the SEC, he failed to take meaningful action to further investigate. In addition, he separately received an unsolicited document from the company's director of internal audit that questioned the business purpose of certain of the expense reimbursement payments. Although he assured the director of internal audit that he would address her concerns with the CEO, he did not. The SEC alleges that Raval's report to the board omitted critical facts, such as the incomplete documentation and his own inadequate investigation. Subsequently, a new director of internal audit raised questions to Raval related to reimbursements and proxy disclosure deficiencies. Raval did not discuss these concerns with the board or disclosure counsel, nor did he respond to similar information provided by counsel in response to a shareholder inquiry.

While there were general references in the company's 10-K and proxy to the related-party transactions and reimbursements (e.g., payment of certain amounts for "use of the aircraft and other travel expenses" ), the SEC charges that Raval knew, or was reckless in not knowing, that these disclosures were false and misleading because the payments involved items other than simply use of the aircraft and because significant amounts involving transactions with the CEO's entities were not disclosed or were materially understated (e.g., failure to disclosure a related-party purchase of a jet interest). Perquisites alone were understated by $9.5 million.

The SEC concluded that "Raval had a duty to take steps to ensure the accuracy and completeness of the statements contained in the company's Commission filings. Raval, however, failed to take appropriate action with respect to significant red flags…." Had Raval further investigated, hired outside counsel or others to investigate or brought facts to the attention of the board, auditor or disclosure counsel, the SEC alleges that the fraud might have been uncovered sooner. Accordingly, Raval was charged with primary violations of Rule 10b-5 and 14a-9, as well as aiding and abetting. Raval settled the action by consenting to an injunction, a $50,000 civil money penalty and a five-year officer/director bar. (Needless to say, the CEO, the company and two former CFOs were also charged.)

While the facts of this case may seem particularly appalling, the SEC's charges should nevertheless give directors (and other gatekeepers) pause: "red flags" are not to be ignored; investigations should not be undertaken lightly or without adequate support, including outside counsel or auditors where appropriate; and facts discovered should be properly communicated to the rest of the board, including coordination with counsel for disclosure in SEC filings as necessary.

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