It’s Not Just the Response, It’s the Disclosure
SEC Charges Against a Company and Its General Counsel Highlight Importance of Disclosing False Claims Act Investigations
A recent complaint filed by the Securities and Exchange Commission highlights some important considerations for companies and in-house counsel facing False Claims Act investigations. The action is SEC v. RPM International and Moore, and was filed in the U.S. District Court for the District of Columbia on September 9, 2016. The SEC contends that RPM and Edward Moore, its General Counsel and Chief Compliance Officer, failed to disclose material facts about a pending FCA investigation and, by doing so, made false and misleading filings with the SEC. The SEC’s complaint is notable for its pursuit of claims against Moore on an individual basis, and it underscores how critical it is for companies not just to respond to a pending FCA investigation, but also to properly disclose and account for potential liability arising from an investigation.
The SEC charged RPM and Moore with violations of Sections 17(a)(2) and (a)(3) of the Securities Act, which prohibit fraud in the offer or sale of securities. According to the SEC’s complaint, the failure to properly disclose the FCA investigation amounted to material omissions and statements of untrue fact, both of which are actionable under the Act.
The chain of events leading to the SEC’s suit began in July of 2010, with the filing of a qui tam action against RPM and its subsidiary, Tremco, Inc., a company that provided roofing systems to the federal government and private customers. The whistleblower there was Gregory Rudolph, who in twenty years with Tremco had worked his way up from roofing technician to Vice President of Product Management/Research & Development. Rudolph had resigned from Tremco in 2009. His FCA claim alleged that Tremco had, for years, knowingly violated its contractual obligation to the federal government to provide it with complete and accurate information about its sales and pricing practices and to pass along any applicable discounts to the government. He also claimed that there were deficiencies in Tremco’s fire-testing of roofing products being sold to the government, and that Tremco had hidden the potential failure rates of certain roofing products from the government.
The SEC complaint focuses on Moore’s handling of the response to Rudolph’s FCA claim. According to the SEC, the Department of Justice provided a copy of the FCA complaint to Moore on August 9, 2012. RPM engaged in negotiations with the DOJ, and on October 1, sent the DOJ an analysis estimating that RPM had overcharged the government by roughly $11.4 million dollars during the period alleged in the FCA complaint. This was a substantial amount for RPM, representing approximately 30% of its net earnings for fiscal quarter that ended August 31, 2012. But the SEC says that Moore and RPM failed to record an accrual for the amount of the potential liability, or to disclose it at all, in filings it made with the SEC between October 3 and October 19, 2012. The SEC alleges that Moore failed to make this disclosure despite being advised in June of 2012 by RPM’s outside audit firm about the duty to disclose government investigations.
The SEC also alleges that Moore attended a seminar about FCA claims in November of 2012, where he learned that the DOJ typically seeks to settle FCA claims for twice the amount of damages sustained from the false claims. In December of 2012, according to the SEC, RPM revised its estimate of overcharges upwards to $11.9 million, and Moore had discussions with RPM’s outside counsel about proposing a settlement in the range of $27-28 million. Also that month, Moore certified to the audit firm that neither he nor his department had given attention to potential losses exceeding $1.2 million. And the SEC alleges that the company made filings with the SEC on January 8, 2013 that also failed to disclose this potential liability.
On January 11, 2013, RPM sent the DOJ a proposal to settle the FCA claim for $28.3 million. The DOJ made a counter-offer of $71 million on March 29, 2013. On April 1, RPM recorded an accrual relating to the investigation, in the amount of $68.8 million, and disclosed the investigation and accrual in filings with the SEC on April 4. In August of 2013, RPM settled the FCA claim for approximately $61 million. The whistleblower, Gregory Rudolph, received $10.9 million from the settlement.
In July of 2014, RPM’s audit firm learned of the overcharge estimates that RPM had sent to the DOJ in 2012, and informed RPM that it would not sign off on the company’s upcoming 10-K filing unless the company investigated the disclosures relating to the FCA claim. RPM’s audit committee engaged outside counsel to conduct that investigation and shared its findings with the audit firm on August 10, 2014. Within days, RPM filed 8-K disclosing the restatement of its financial statements for first, second, and third quarters of fiscal year 2013 and filed amended 10-Qs for quarters ending August 31, 2012 and November 30, 2012.
According to the SEC, Moore and RPM are liable for failing to disclose the FAC investigation accurately, completely, and timely. The SEC alleges that several factors contributed to this failure. For instance, the SEC states that a disclosure would have affected RPM’s share price, and as of August 31, 2012, Moore owned 65, 952 shares of RMP stock worth more than $1.8 million, and 65,000 RPM stock options. The SEC also alleges that RPM’s audit committee had stated in 2012 that “we’re not going to be accepting of ongoing extraordinary charges or one-time charges,” putting pressure on Moore to avoid making an accrual for the amount of the potential FCA liability. The SEC also states that Moore received bonuses of $300,000 in July of 2013 and $400,000 in July of 2014 that were tied to RPM’s financial results – which would have been negatively impacted by disclosure of the FCA action.
Whether the SEC’s allegations will hold up in court or not, this complaint should serve as a cautionary tale for any company facing FCA claims. Full and timely disclosure is necessary, and companies should be on the lookout for dynamics, such as compensation and bonus structures and warnings about one-time charges, that might discourage such disclosure. And legal officers should be especially careful in handling responses to FCA actions, given the SEC’s evident emphasis on individual liability in these cases. As this SEC complaint shows, the potential ramifications of an FCA action aren’t limited to the claim itself, but can also arise from a company’s response to the claim.