Cooperation with SEC: Yielding More Benefits, but Lack of Predictability Remains

Although the SEC has long adhered to its Seaboard Report of Investigation to outline the analytical framework for the agency's cooperation program for companies, the exact benefits of self-policing, self-reporting, cooperation and remediation with the agency remain opaque. In light of the SEC's recent settlement with GTT Communications Inc. (GTT), whereby the agency did not impose a civil monetary penalty against the publicly traded company despite violations of (among other things) the negligence-based antifraud provisions, it is worth revisiting the SEC's Seaboard framework and the agency's recent trend of foregoing civil penalties. In this post, we offer a brief overview of the GTT settlement, revisit some of the key factors the SEC has typically considered as cooperative and remedial, touch on a recent DOJ declination as a data point for comparing cooperation programs and offer some key takeaways for companies and counsel to consider when it comes to cooperation.

A Brief Refresher on Cooperation

When we last discussed successful remedial measures, we examined how tech company HeadSpin Inc. secured a no-money penalty settlement with the SEC relating to an alleged $800 million inflation of the company's annual recurring revenue by its CEO. In that post, we noted that, following in HeadSpin's footprints, a company may be able to secure cooperation credit by engaging in a combination of identifying wrongdoers, self-policing misconduct, conducting an effective and impartial internal investigation, removing ineffective management, taking actions to remedy harm to investors and remediating deficient policies.

From the SEC's perspective, it is clear that to simply "go-along to get-along" is not enough to garner leniency from the Commission. As Chair Gary Gensler put it recently, while noting that the SEC ordered "zero or reduced penalties" based on the respondents' cooperation in "numerous actions" last fiscal year, meaningful cooperation involves "more than showing up for testimony or producing documents under subpoena. It means going above and beyond to self-report, cooperate and remediate." Thus, entities that have taken more convincing remedial measures, such as sharing results of an internal investigation with the staff or preemptively ousting alleged wrongdoers, tend to start on the front foot when undergoing investigation.

The GTT settlement offers a helpful peek behind the enforcement curtain and highlights ways companies can cooperate with the staff.

The GTT Settlement Offers a Primer on Beneficial Remedial Measures

The settlement with GTT involved its alleged failure to disclose material information about unsupported adjustments the company made in several SEC filings that increased GTT's reported operating income by at least 15 percent in three quarters. During the relevant time of the order, GTT was a publicly traded multinational telecom and internet service provider. Critical to the company's reporting was its largest operating expense: direct costs incurred in providing telecommunications services to customers. However, after enjoying significant growth following eight acquisitions in 2017 and 2018, the company realized it had discrepancies in its internal cost-of-revenue accounting methodology. GTT's accounting problems purportedly stemmed from two major sources: rapid expansion, resulting in a struggle to reconcile data between the company's internal accounting programs, and misalignment between accounting and operations personnel.

GTT's rapid-fire expansion purportedly led to issues almost immediately. The company was acquiring private, distressed foreign companies whose accounting and operations processes did not align with GTT's. In turn, the company's employees could not keep up with the new influx of data and transactions amidst the integration of that data into GTT accounting systems. By 2019, GTT was processing more than 600,000 transactions each month and could not review the invoices manually due to a lack of resources.

Two of GTT's accounting programs allegedly posed significant issues after the company's numerous acquisitions: 1) an internally developed platform used to manage contracts with networks, clients and suppliers and 2) a billing system used to process vendor invoices. Critically, the former program monitored GTT's expenses from customer services, and the latter contained expenses based on invoices received from vendors. By the middle of 2018, GTT purportedly became aware that a "persistent and growing discrepancy" existed between the amounts paid in invoices compared to the expected costs. The SEC's order found that GTT could not assess the cause of the discrepancy because it was unable determine an efficient way to compare the data between its accounting systems.

Further, according to the SEC's order, GTT's accounting and operations employees "were confused as to the other's role: operations did not fully appreciate how accounting used the data they provided, and accounting did not fully understand what the data reflected and its limitations." As a result, it was not until mid-2019 that the accounting and operations teams had determined that they would not have a reliable data source to base their cost of revenue without an arduous manual comparison of the data in the two systems.

These issues allegedly resulted in GTT making multiple misleading statements and omissions in its public disclosures. GTT was unable to effectively resolve its accounting errors amidst its reporting obligations. As a result, major adjustments to cost of revenue were allegedly speculative or otherwise lacked support, rendering disclosures "materially misleading in light of the circumstances," according to the SEC.

After discovering the accounting errors, GTT endeavored to resolve them and, in doing so, undertook "affirmative remedial measures" credited by the staff, including many of the actions we identified in our earlier post. Specifically, GTT voluntarily:

• self-reported promptly to the SEC
• undertook an internal investigation and shared its findings with the staff, including preliminary findings while the investigation was underway but not yet concluded
• identified witnesses and key documents and made them available to the staff promptly
• facilitated testimony from former employees
• based on the findings of the internal investigation, attempted to rebuild its cost-of-revenue accounts, replaced members of management, its board of directors and its auditor and revamped its accounting functions, including related policies and procedures

Despite more than a year of work and spending "tens of millions of dollars," GTT was unable to reconcile its two accounting systems and filed for bankruptcy in 2021. GTT now operates as a private company.

Ultimately, GTT entered into a settled order with the SEC, in which it agreed to cease and desist from violating the negligence-based antifraud provisions of the Securities Act of 1933 (Sections 17(a)(2) and 17(a)(3)) and the reporting, books and records, internal accounting controls, and disclosure controls and procedures provisions of the Securities and Exchange Act of 1934 (Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Rules 13a-1, 13a-11, 13a-13, 13a-15(a) and 12b-20 thereunder).¹

The DOJ Will Also Reward Remediation

The SEC is not the only agency rewarding comprehensive remediation lately. On Oct. 25, 2023, the Fraud Section of the Criminal Division of the U.S. Department of Justice (DOJ) issued a non-prosecution letter announcing it was declining to prosecute HealthSun Health Plans Inc. (HealthSun) despite "the fraud committed by employees and agents" of the company in violation of 18 U.S.C. Sections 1343, 1347 and 1349. The DOJ's investigation found evidence that, from 2015 to early 2020, one of HealthSun's former directors orchestrated a scheme to submit false and fraudulent information about diagnoses for chronic ailments that enrollees in the company's Medicare Advantage Plan did not have or that were entered into patient healthcare records by non-healthcare providers to the U.S. Department of Health and Human Services' Centers for Medicare & Medicaid Services (CMS). The scheme allegedly resulted in $53 million in overpayments by CMS to HealthSun.

In the letter, the DOJ cited several factors set forth in its revised Criminal Division Corporate Enforcement and Voluntary Self-Disclosure Policy, including: 1) timely and voluntary self-disclosure, 2) "full and proactive cooperation," including providing all known relevant facts, including information obtained from company and personal cellphones and the identity of individuals involved and agreeing to continue cooperating through any future investigations or prosecutions, 3) the nature and seriousness of the offense, 4) timely and appropriate remediation, including terminating involved employees, reporting and correcting false information submitted to CMS, substantially improving the company's compliance program and internal controls through, among other things, significant investment in designing, implementing and testing a risk-based and sustainable Medicare Advantage compliance program and 5) remitting more than $53 million that CMS overpaid to HealthSun allegedly as a result of the fraudulent scheme.

Takeaways

• Cooperation and Remediation Guideposts Reinforced: The GTT order presents the latest settlement to reinforce our primer on areas the SEC prioritizes when it comes to cooperation and remediation. As a refresher:

For cooperation, the agency has highlighted the following for an entity subject to SEC investigation: 1) retained independent counsel who, with the aid of subject-matter experts, conducted an independent internal investigation, 2) typically through independent counsel, voluntarily shared the results of the internal investigations to save the Enforcement staff time and resources, and 3) as appropriate, shared with the staff relevant documents and voluntarily provided targeted analyses to the staff.

Remediation is a more fact-specific analysis, but a review of settled orders similarly reveals common patterns whereby the entity in question: 1) after discovering the misconduct, either convened a special committee of independent directors or, as appropriate, elevated issues to the audit committee, 2) identified individuals responsible for – or otherwise complicit in – the wrongdoing and terminated their employment, 3) removed personnel from executive positions who, although not responsible for or otherwise complicit in the wrongdoing, failed to carry out their responsibilities to prevent such wrongdoing or were otherwise unqualified for their executive positions, 4) hired new, qualified personnel, retained subject-matter experts to correct prior deficiencies and/or elected new board members with appropriate subject-matter expertise, 5) implemented new internal control and compliance policies and procedures and started new training programs on the deficient areas at issue and 6) if necessary, instituted legal action against wrongdoers to seek monetary recovery.

• GTT Bankruptcy Likely a Factor: There is little doubt that GTT checked off a number of Seaboard boxes concerning its response to the issues detailed in the SEC's order. As noted above, many of these actions are the type emphasized by the SEC when it credits a company's cooperation. However, one cannot overlook GTT's current financial situation when it comes to the result in this matter.

Historically, the SEC has been more willing to forego a civil monetary penalty when a company files for bankruptcy for several reasons. First, if this matter was to be filed as litigated in district court – a likelihood given the various constitutional issues the SEC is facing concerning litigated administrative proceedings – a district court would generally consider a variety of factors before imposing a civil penalty, such as 1) the egregiousness of the defendant's conduct, 2) the degree of the defendant's scienter, 3) whether the defendant's conduct created substantial losses or the risk of substantial losses to other persons, 4) whether the defendant's conduct was isolated or recurrent, and 5) whether the penalty should be reduced due to the defendant's demonstrated current and future financial condition. Second, given the agency's low likelihood of recovery of any civil penalty in a bankruptcy proceeding, the SEC historically has been more willing to forego seeking the imposition of a civil penalty in these circumstances.

• Seaboard Remains a Useful Guidepost on What Constitutes Cooperation, but Magnitude of Cooperation Benefits Remain Opaque. There is considerable overlap between the factors cited in the GTT (and Headspin) settlement orders and the DOJ's policy. The pillars of self-policing, self-reporting, cooperation and remediation are foundational to both programs.

Where the programs differ is in the predictability of results from engaging in these activities. Under the DOJ policy, the government will not seek a guilty plea where a company has voluntarily self-disclosed pursuant to the criteria set forth in the policy, fully cooperated and "timely and appropriately remediated the criminal conduct," pursuant to relevant provisions of the Justice Manual and DOJ policy. Additionally, where a guilty plea is warranted due to aggravating factors, but where a company otherwise complies with the requirements of the policy, the government will recommend a fine reduction based on a specific percentage and not impose other relief often seen in criminal proceedings involving companies, such as the appointment of an independent compliance monitor.

By comparison, although the Seaboard Report and various SEC settled orders respectively provide an analytical framework and appropriate guideposts for companies to consider on what exactly constitutes cooperation, the benefits of that cooperation remain subject to the Commission's "facts and circumstances" determination. The lack of a specific framework for the tangible benefits of cooperation means that companies and counsel must continue to hypothesize about how cooperation may benefit a company in a given situation.

• Lack of Monetary Penalty Is Still Rare in Settlements but Was More Frequent in Fiscal Year (FY) 2023. For context, in all of the settlements in the SEC's prior FY, only 3 percent of public companies avoided the imposition of a penalty.² However, a recent report by Cornerstone Research covering the SEC's FY 2023 enforcement results revealed that during the last fiscal year "13% of [public company] defendants that cooperated settled without monetary penalty. This is more than triple the average rate over FY 2014-FY 2022."

The increased amount of no-penalty settlements, particularly during a time of aggressive enforcement, is a positive data point for companies assessing the benefits of cooperation with their primary securities regulator. However, it should be noted that although the SEC was far more willing to not impose a civil monetary penalty against cooperating entities, the typical result for cooperating entities remains a settlement with some civil penalty component. For example, nearly 70 percent of the public companies that settled with the SEC in FY 2023 were deemed to have cooperated, yet the Commission imposed a civil penalty on the overwhelming majority. And, as noted above, given that certain unique factors (such as company bankruptcy) could skew results, it may be a bit early to describe this as a trend.

The SECond Opinions Blog will continue to monitor these developments and provide further updates. If you need additional information on this topic – or anything related to securities enforcement or investigations – please contact the authors or other members of Holland & Knight's Securities Enforcement Defense Team.

Notes

¹ Securities Act Section 17(a)(2) prohibits any person from obtaining money or property in the offer or sale of securities by means of any untrue statement of a material fact or any failure to state a material fact necessary in order to make the statements made, in light of the circumstances in which they were made, not misleading. Securities Act Section 17(a)(3) prohibits any person from engaging in any transaction, practice or course of business that operates or would operate as a fraud or deceit upon the purchaser. Exchange Act Section 13(a) and the cited rules thereunder require every issuer to file with the Commission annual, current and quarterly reports that contain material information as may be necessary to make the required statements not misleading. Exchange Act Section 13(b)(2)(A) requires issuers to make and keep accurate books, records and accounts. Exchange Act Section 13(b)(2)(B) requires issuers to, among other things, devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and Rule 13a-15(a) requires that issuers maintain disclosure controls and procedures and internal controls over financial reporting.

² See SEC Enforcement Activity: Public Companies and Subsidiaries, Fiscal Year 2022 Update, Cornerstone Research (Sept. 27, 2022), which reports that 97 percent of Enforcement settlements included a monetary penalty. The SEC released its 2023 Enforcement Results on Nov. 14, 2023. They do not include the number of settlements without a monetary penalty. Stay tuned for our future blog post with a summary.