SEC Targets Corporation and Its General Counsel For Allegedly Failing to Properly Disclose or Record an Accrual for a Loss Contingency Due to a False Claims Act Investigation

On September 9, 2016, the Securities and Exchange Commission filed in U.S. District Court for the District of Columbia a civil lawsuit against a government contractor, RPM International, Inc., and its General Counsel, alleging they had failed timely to disclose a loss contingency and record an accrual for a DOJ FCA investigation that the company ultimately settled for $60.9 million.

The following is a summary of the SEC’s allegations, none of which have been proven. DOJ’s FCA investigation of the company began in March 2011, in response to a qui tam lawsuit’s allegations that one of RPM’s wholly-owned subsidiaries, Tremco, Inc., had overcharged the government on certain contracts.  RPM’s General Counsel oversaw the company’s response to the DOJ investigation.

DOJ provided a copy of the FCA complaint to RPM in August 2012, and in September of 2012 the company’s outside counsel met with DOJ to discuss the investigation.  At that meeting, the company’s counsel told DOJ that the company had not complied with the pricing terms of its government contracts, and that an analysis prepared by a consultant to RPM calculated that the company had overcharged the government by at least $11 million.  Approximately three weeks later, the General Counsel sent a management representation letter to the company’s outside auditors stating that neither he nor outside counsel had represented the company in connection with a material loss contingency exceeding $1.2 million.  The same day that the management representation letter was sent, the company sent DOJ a written analysis echoing what its counsel had presented three weeks earlier.  Notably, the SEC alleges that the company and its General Counsel should have recognized that the probable loss was even higher, since the $11 million calculation addressed only part of the time period and only one of the contracts under investigation and did not account for the fact that, as the complaint states, “in order to settle an FCA matter, DOJ generally required at least two times the amount of actual damages sustained from the false claims.”

The SEC’s complaint charges that the company then filed a Form 8-K with an attached earnings release on October 3, 2012 and a Form 10-Q on October 4, 2012, and that both were misleading because they failed to include an accrual for a loss related to the DOJ investigation as a charge against income.  The SEC also claimed that the 10-Q was false and misleading in that it asserted that the company’s disclosure controls and procedures were effective in ensuring the submission of proper reports.

In December 2012, outside counsel and RPM’s General Counsel held a conference call with DOJ and discussed a settlement of the investigation that would involve single damages in the range of $27-28 million.  A week later, the General Counsel sent the outside auditors another management representation letter that, again, stated that neither he nor outside counsel had represented the company in connection with a material loss contingency exceeding $1.2 million.  At about that same time, the General Counsel told the outside auditors that no claim had been filed against the company in connection with the matters under investigation by DOJ and that no loss contingency existed.

The company filed a Form 8-K and a Form 10-Q on January 8, 2013.  By this time, the SEC claims, the General Counsel knew “it was reasonably likely that the DOJ investigation would have a material unfavorable impact on RPM’s income in the future because the likely floor for RPM’s range of loss was $27-28 million, even before considering the impact of a damages multiplier under the FCA.”  Yet, the company’s SEC filings of January 8, 2013 did not disclose any information or accrual relating to the DOJ investigation.  The disclosures also misrepresented that the company’s disclosure controls and procedures were effective.

Up to this point in time, the General Counsel allegedly had told the outside audit firm only that the range of loss was approximately $5 million.  On January 10, 2013, the General Counsel allegedly told the company’s CEO that the range of loss had grown from $5 million to $27-28 million.  The next day, the company submitted a settlement offer to DOJ of $28.3 million, which comprised the amount of the calculated overcharge without an FCA multiplier.  On March 29, 2013, DOJ countered at $71 million, which figure included a multiplier of 2.5.  Thereafter, the company recorded an accrual of $68.8 million.  As DOJ announced in an August 28, 2013 press release, the parties ultimately settled the DOJ investigation for $60.9 million.

The SEC claims that the General Counsel continued after the settlement to make misleading statements to the outside auditors, including that the range of reasonably possible loss  was no more than $10 million until early January 2013.  In August 2014, RPM restated its financials for the first three quarters of 2013 to correct errors in disclosing and accruing for the loss relating to the DOJ investigation.

The complaint asserts seven separate claims for relief – two against both RPM and its General Counsel, under Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933; three against RPM alone, under Sections 13(a) (and associated Rules), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act; and two against the General Counsel alone, under Rules 13b2-1 and 13b2-2(a) of the Exchange Act.

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As any practitioner experienced with FCA investigations of public companies can attest, questions regarding what can be disclosed about the investigation, and when, arise frequently.  Disclosure counsel should be involved and fully informed in any such decisions.