Two recent settled actions suggest that SEC Enforcement seems to be scrutinizing disclosures about related-person transactions—or rather, the absence thereof. The first, announced last week against Maximus, Inc., looks like a flub by the company in failing to disclose the employment of two immediate family members of a new executive. Maximus was required to pay a civil penalty of $500,000. The second settled action, against Lyft, involved the failure by the company to disclose the role of, and related compensation received by, a board member in architecting the sale by a shareholder of approximately $424 million worth of Lyft shares prior to the company’s IPO. According to the Order, “Lyft, which approved the sale and secured a number of terms in the contract, was a participant in the transaction.” Lyft was required to pay a civil penalty of $10 million. According to an SEC Associate Regional Director, the “federal securities laws required Lyft to disclose that a director profited from a transaction in which Lyft itself was a participant….We remain vigilant in ensuring investors are not deprived of critical information about transactions occurring close to a company’s initial public offering.” With Enforcement’s spotlight apparently now on disclosure of related-person transactions, companies may want to beef up their due diligence processes and disclosure controls around these types of transactions.
Maximus. Both Forms 10-K and proxy statements (involving the election of directors) require disclosure under Reg S-K Item 404, Transactions with related persons, promoters and certain control persons. Under Item 404, as the Order highlights, companies are required to provide
“a description of transactions since the beginning of the registrant’s last fiscal year in excess of $120,000 in which the registrant was a participant and any ‘related person had or will have a direct or indirect material interest.’ For purposes of Item 404, a ‘related person’ includes any immediate family members of the executive officers of the registrant, and ‘immediate family members’ include siblings of executive officers. Disclosure of related person transactions ‘involving the employment of immediate family members’ is required ‘when the threshold for disclosure has been met and the immediate family member has or will have a direct or indirect material interest.’”
As stated in the Order, in 2019, a “business segment leader and longtime employee” was appointed by the Board to be an executive officer, as defined in Rule 405. The new officer also had two siblings who were longtime employees of Maximus, each with annual compensation in excess of the reporting threshold of $120,000. The Order alleges that “in each instance, the executive officer’s siblings were related persons who had a direct or indirect material interest in the transactions.” Nevertheless, the company’s proxy statements (incorporated in part into its Forms 10-K) for 2020 and 2021 stated that Maximus had no related-person transactions during those fiscal years.
As a result of these disclosure failures, the SEC charged Maximus with violation of Section 13(a) of the Exchange Act and Rule 13a-1 thereunder, and Section 14(a) of the Exchange Act and Rule 14a-3 thereunder. After taking into account the company’s cooperation and remediation, including self-reporting of this issue to the SEC staff, the SEC ordered Maximus to pay a civil penalty of $500,000.
Lyft. The SEC’s charges against Lyft, which “operates multimodal transportation networks,” involved the alleged failure by Lyft to disclose, under Item 404, a transaction in which Lyft was considered a participant and in which a related person, a director, had a material interest in an amount exceeding the reporting threshold of $120,000.
According to the Order, in connection with its IPO in March 2019, Lyft requested that officers, directors and most shareholders sign lock-up agreements. However, one Shareholder, who owned 7.7 million shares and who appointed a Director to Lyft’s Board “to represent Shareholder’s interests,” refused to sign, instead requesting Board approval (as required under its agreement) to sell its shares. The Board initially rejected the Shareholder’s request, concerned that potential inside information of its representative Director would be attributed to the Shareholder. To alleviate Board concerns, the “Director proposed to Lyft that Shareholder sell its stake to Director or an affiliate of Director in a private transaction.” A board special committee approved this arrangement on specific terms in March prior to the IPO.
The Order alleges that the Director then solicited an unaffiliated potential Investor to purchase the shares. The Investor agreed, and the Director, Shareholder and Investor entered into a transaction in which, prior to the IPO, the Investor would, indirectly through two entities controlled by Investor, become limited partners of a newly formed special purpose vehicle that would acquire all of the Shareholder’s shares at a discount to the anticipated IPO price. As alleged in the Order, the SPV was managed by an Investment Advisor, of which the Director was an employee, receiving both a fixed salary and compensation for “bringing investment opportunities to Investment Adviser.” The Order states that the “Director did not disclose his compensation or his material interest in the transaction to Lyft.” On March 15, at the Shareholder’s request, to avoid potential HSR control issues, the Director resigned from Lyft’s Board. The transaction had a value of approximately $424 million.
How did Lyft participate? Because its consent to transfer was required, the Order states, Lyft signed the stock sale agreement. In addition, Lyft was involved in review and modification of the agreement. According to the Order, Lyft required certain terms in the agreement, including some terms that were part of the original stock purchase agreement and a waiver by the SPV of certain rights that would have otherwise transferred with the shares. The sale agreement also recited that the SPV purchasing the shares had a relationship with a Board member as of the date of this Agreement, and was not relying representations by Lyft.
Under the partnership agreement forming the SPV, the Investment Advisor would receive management fees and performance fees based on pre-and post-IPO gain on the shares, and the Director would receive 50% of the management fees and 85% of the performance fees. Consequently, the Order alleges, the Director was to receive $9.8 million as a result of his role in facilitating the sale of Shareholder’s Lyft shares (although subsequent negotiations led to a reduction of the amount).
Under Item 404(a), the Order states, the company is required to describe “transactions since the beginning of the registrant’s last fiscal year in excess of $120,000 in which the issuer was or is to be a participant, and in which a related person had or will have a direct or indirect material interest. The sale of Shareholder’s stake qualified as a related person transaction requiring disclosure in Lyft’s 2019 10-K.” However, neither the 2019 Form 10-K nor any subsequent Exchange Act filings disclosed “either the sale of Shareholder’s stake nor Director’s expected compensation from his role in the sale.”
The SEC concluded that Lyft violated Section 13(a) of the Exchange Act and Rule 13a-1 thereunder, and ordered Lyft to pay a civil penalty of $10 million.
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