As we continue our review of FY 2021 SEC enforcement activity, we turn our attention to a topic that, if not already a key focus for publicly traded companies, should be. As part of their effort to recruit and retain leadership, public companies often provide benefits to their executives beyond salary and performance-related bonuses, such as use of a corporate aircraft, car allowances or country club memberships. These compensation arrangements, known as perquisites – or, more commonly, perks – are subject to specific executive compensation disclosure requirements under the SEC's proxy disclosure rules. As our review of the SEC's enforcement activity shows, these disclosures will be a hot-button enforcement issue for the foreseeable future.
Relevant Disclosure Obligations
Section 14(a) of the Securities and Exchange Act of 1934 makes it unlawful for public company issuers to solicit a proxy for most of its securities without complying with specific proxy rules and regulations. In turn, Item 402 of Regulation S-K requires issuers to disclose in proxy materials the total value of "executive compensation" for "named executive officers" – 17 C.F.R. § 229.402. Much of what comprises executive compensation – salary, bonuses, stock awards – is obvious. But Item 402 also calls for the disclosure of "[a]ll other compensation," a catchall bucket that requires companies to disclose, among other things: 1) the total value of all perks and other personal benefits provided to named executive officers1 who received at least $10,000 worth of such items in a given year and separate them out by type; and 2) each perk or personal benefit that exceeds the greater of $25,000 or 10 percent of the total amount of perks and personal benefits for that officer must be quantified and disclosed in a footnote.
Naturally, this begs the question: What's a perk? The SEC has provided the following guidance:
An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive's duties. Otherwise, an item is a perquisite or personal benefit if it confers a direct or indirect benefit that has a personal aspect, without regard to whether it may be provided for some business reason or for the convenience of the company, unless it is generally available on a non-discriminatory basis to all employees – SEC's Executive Compensation and Related Person Disclosure Final Rule adopting release, Release Nos. 33-8732A; 34-54302A; IC-27444A; File No. S7-03-06 (August 29, 2006).
Importantly, even where the company determines that an expense may be "ordinary" or "necessary" for tax or other purposes, that determination is "not responsive to the inquiry of whether the expense provides a perquisite or other personal benefit for disclosure purposes." Id.
SEC FY 2021 Perks-Related Enforcement Actions
Although perks actions are not a new addition to the SEC's enforcement program (as shown by actions in recent years against Dow Chemical and Hilton Worldwide Holdings), the agency's enforcement activity in this space is coming with increased frequency. On the heels of an active FY 2020, the SEC continued to closely scrutinize and, when it deemed appropriate, take action against issuers for allegedly deficient perks-related disclosures. Here's a boiled-down look back at three significant cases from the last year.
In In re Gulfport Energy Corp., Exch. Act Rel. No. 91196 (Feb. 24, 2021), the SEC announced settled charges against the company and a former executive for deficient perks-related disclosures tied to, among other things, the former executive's use of a chartered aircraft and company credit cards.2 Over a four-year period, the former executive caused Gulfport to incur approximately $650,000 in charges traveling on charted aircraft for reasons such as attending a wine tasting in Napa and a poker tournament in Las Vegas. The SEC's settled order also found that the former executive charged $450,000 on company credit cards where he wasn't required to repay the expenses when due, amounting to receipt of interest-free credit (sometimes in excess of $120,000). The SEC's order found that such travel and credit card arrangements "were not internally and directly related to the performance of his duties, and not generally available on a non-discriminatory basis" to all Gulfport employees. Without admitting or denying the findings therein, Gulfport settled to violations of the reporting and proxy rules under the Exchange Act.3 The SEC ordered Gulfport to cease and desist from further violations of these provisions but, as discussed further below, did not impose any penalty.
In In re National Beverage Corp., Exch. Act Rel. No. 92560 (Aug. 4, 2021), the SEC again charged an entity tied to deficient disclosures around executive aircraft travel. From 2016 to 2020, National Beverage's CEO took approximately 33 trips financed by National Beverage to various domestic and international locations. None, however, were "integrally and related to his job duties." As such, National Beverage understated its disclosed perquisites over a five-year period by approximately $735,647. The SEC also found that National Beverage lacked adequate disclosure controls and procedures (DCP) under Exchange Act Rule 13a-15(a) to ensure that issuer's management received information about executive perks to determine if they needed to be disclosed in its proxy statements. Notably, the SEC found that National Beverage never tracked or analyzed the CEO's flights and didn't train its employees on how to classify certain expenses for disclosure purposes. Without admitting or denying the findings, National Beverage agreed to a settled order that it violated the reporting and proxy rules, a cease-and-desist order from further violations of those provisions and a civil penalty of $481,920.
Most recently, in In re ProPetro Holding Corp., Exch. Act Rel. No. 93645 (Nov. 22, 2021), the agency charged the entity and its former CEO in a case that echoes the Gulfport matter. Specifically, the agency charged the entity and former executive for their roles in the company's failure to disclose more than $428,000 in aircraft-related travel and credit card expenses by the company's former CEO over a two-year period.4 ProPetro's CEO used a private aircraft mostly for activities integrally related to the executives duties, but the SEC order found that he used approximately 10 percent of his travel had a personal aspect. The SEC also found that pilots on the company's payroll flew a plane co-owned by the former CEO for the CEO's personal travel. Additionally, the former CEO used ProPetro credit cards for more than $127,000 in personal charges. Without admitting or denying the findings, ProPetro agreed to cease and desist from further violations of the reporting, books and records, and proxy provisions of the Exchange Act. As with Gulfport, the commission did not impose a penalty on the entity.5
A Look Ahead to 2022
No one knows what 2022 holds – especially these days – but there is no indication the SEC intends to pump the brakes on executive perks actions. In the recent words of David Peavler, regional director of the SEC's Fort Worth Divisional Office, "[t]he federal securities laws are crystal clear: issuers must accurately disclose and record executive compensation and stock ownership."
Although the general expectation is not surprising, we can use FY 2021 activity to highlight some interesting takeaways. First, in both the Gulfport and ProPetro matters, the agency focused on executives' failures to provide relevant perks-related information in D&O questionnaires. This should serve as a signpost for public companies that the SEC's enforcement staff will be scrutinizing this process for issuers going forward and a warning to ensure their policies and procedures in this area are robust.
Second, and more beneficial for issuers, even in the age of aggressive enforcement and higher penalties, the agency did not impose civil penalties against either Gulfport and ProPetro, citing the cooperation and remedial acts of both entities. This serves as a healthy reminder that if issuers identify possible perks-related disclosure issues, retaining experienced SEC counsel quickly could open a path to a beneficial resolution. Of course, the National Beverage Corp. and Hilton matters identified above included significant penalties in the hundreds of thousands of dollars. As such, resolutions in this space will be dictated by the facts and circumstances of not only the alleged misconduct, but also the entities' cooperation and remediation thereafter.
Third, exposure for perks-related misconduct is not limited to entities. In certain circumstances, as the orders against former Gulfport and ProPetro executives demonstrate, named executive officers can be held directly liable for fraud and proxy violations associated with false and misleading perks disclosures, as well as for causing an issuer's misleading public reports.
As the SEC continues to pursue actions in this space, we'll be here to provide updates on noteworthy developments. For more information, or to examine the impact SEC regulatory compliance may have on your business or practices, contact the authors or another member of Holland & Knight's Securities Enforcement Defense and White Collar Defense and Investigations teams.
Notes
1 See Item 402(a)(3) of Regulation S-K for details on who qualifies as a named executive officer.
2 The SEC also sued Gulfport for its failures to disclose certain related party transactions with the former executive under Item 404 of Regulation S-K.
3 In a separate order, as a result of this misconduct, the former executive was found to have violated the negligence-based antifraud provisions of the Securities Act of 1933, the same proxy-based proxy provisions as the company, to have caused Gulfport's reporting violations and to have falsified a book, record or account subject to Section 13(b)(2)(A) of the Exchange Act. The former executive agreed to cease and desist from further violations of these provisions and agreed to pay a civil penalty in the amount of $88,248.
4 The SEC also sued the company and former executive for failures related to the company's disclosures around the number of shares beneficially owned by the former CEO in its public reports.
5 The SEC's order also found that the former CEO violated the negligence-based antifraud provisions of the Securities Act, the same proxy provisions as the company and for causing the company's books and records and reporting violations. Without admitting or denying the findings, he agreed to a cease-and-desist order and to pay a $195,046 civil penalty.
