In December the SEC suffered a jury trial defeat in SEC v. Kovzan, a civil fraud action alleging that the CFO of NIC Inc. failed to disclose more than $1 million in perquisites to the company’s former CEO. The SEC alleged that the CFO knew or was reckless in not knowing that the perquisites were not disclosed accurately. Not only did the Kansas jury acquit the CFO on all 12 charges, they found in his favor on every question on the jury verdict form.
That defeat was followed by another adverse ruling in December, in SEC v. Jensen. In that case, the SEC charged two former executives of Basin Water Inc. with accounting fraud for improperly recognizing revenue for six transactions, purportedly to disguise the company’s financial performance. The judge found that the SEC failed to demonstrate fraud, as there were no documents or witnesses to support the allegation that these transactions were shams. Further, the judge found there was no direct evidence of scienter or recklessness. While the SEC’s case was premised on allegations of improper accounting, the only evidence of such improprieties was unconvincing witness testimony, according to the court.
Lessons for 2014
The downward trend in SEC enforcement actions against public companies for alleged financial-reporting violations will reverse in 2014. As part of that reversal, the SEC will be making more inquiries, analyzing more periodic reports and financial statements, and ultimately filing more lawsuits. Because the SEC is likely to take an aggressive posture in bringing and litigating cases, 2014 will also see more trials involving financial reporting issues.
If recent experience is any guide, the SEC will not be successful in all of those trials, meaning that some defendants will be put to the expense, reputational damage and emotional turmoil necessary to defend against accusations not supported by the law or facts.
Nicolas Morgan is a partner at law firm DLA Piper and West Coast Chair of the firm’s Securities Enforcement Practice. Jennifer Feldman is of counsel at DLA Piper.