In a case that should serve as a warning to the owners, directors and offi cers of privately-held companies that offer equity plans to their employees, on December 12, 2011, the SEC fi led suit against Stiefel Laboratories, Inc. (at the time of the alleged misconduct, the world’s largest privately held manufacturer of dermatology products and now a subsidiary of GlaxoSmithKline PLC) and Charles Stiefel, the then controlling shareholder, chairman and CEO.4

The SEC alleges that the defendants defrauded current and former employee-shareholders of the company by buying back their stock at severely undervalued prices from 2006 until shortly before the company was sold in 2009. The employees had acquired the stock through the company’s stock bonus plan. The company repurchased shares when employees resigned, died or were terminated and also made a voluntary buyback offer to current employees, ostensibly to permit employees to diversify their retirement holdings. Allegations against the defendants include the following:

  • The purchase price of the stock was based on a valuation made by a third party accountant who “used a fl awed methodology and was not qualifi ed to perform the valuations.” Further, the valuation price was discounted by an additional 35%, which was not disclosed to employees.
  • The stock valuations provided by defendants to employees were misleading because they did not take into consideration:
    • offers from fi ve investment fi rms in 2006 to purchase stock from the company based on a valuations that were 50% to 200% higher than the company valuation provided to employees;
    • the 2007 purchase by a private equity fi rm of $500 million of preferred stock of the company based on a $2.6 billion valuation of the company that was more than three times higher than the company valuation provided to employees; and
    • that the company had become actively engaged in material discussions in 2008 to sell the company and in 2009 had received offers to purchase the company.
  • The stock bonus plan and the summary plan description given or made available to employees were materially misleading because they informed shareholders that stock could be sold for its “current fair market value” which the SEC alleges was not done. Additionally, the plan required the CEO, in his capacity as trustee of the plan, to determine the fair market value “from time to time;” a duty the SEC alleges he failed to perform by not requesting updated valuations or providing the valuation fi rm with material information.

The SEC alleges that the employee-shareholders were defrauded of more than $110 million as a result of the misleading valuations provided by the defendants. The SEC is seeking, among other remedies, disgorgement of ill-gotten gains plus interest, civil penalties and a public company officer and director bar against the individual defendant.

Although the defendants have not yet had their day in court, a number of lessons can be learned from the allegations in the SEC’s complaint:

  • Privately held companies that offer equity plans to employees should have those plans and the accompanying summary plan descriptions carefully reviewed with respect to provisions permitting or requiring stock repurchases.
  • Stock repurchase valuations should be based on commonly accepted methodolo gies and updated as corporate circum stances require.
  • Consider black-out periods when no repurchases of company stock can be effected until updated fi nancial results or corporate events are able to be disclosed.
  • Have your D&O insurance policies reviewed to determine whether you have coverage in the event that the SEC or employee-shareholders bring a securitiesbased action against you. Even if you prevail in the case, the costs of litigation with the SEC or the securities plaintiff bar can make you a loser.