The SEC continues to focus on improper disclosure of executive perquisites. Recently, settlements in two additional SEC enforcement actions involving perks were announced. These actions are consistent with a recent focus by the SEC in this area.
Recent Perk Cases
In July 2018, the SEC issued a cease-and-desist finding involving The Dow Chemical Company relating to allegedly undisclosed perks. As in some other recent cases, the order included a monetary penalty ($1.75 million) and required the retention of a consultant for a period of at least one year. In another recent action, the SEC charged the former CEO of Energy XXI, Ltd., an oil and gas company, with perk violations as well as allegations involving undisclosed personal loans and related party transactions. Other recent cases are discussed in in our February 2018 edition, here.
The Dow case did not allege executive misconduct. Rather, it alleged the failure to properly account for and to disclose approximately $3 million in perks. The SEC alleged that the company inappropriately applied a “business purpose” standard in evaluating perks instead of the SEC’s more rigorous “integrally and directly related” standard. The perks at issue appear relatively common and included travel to outside board meetings, sporting events, club memberships, limited use of personal assistant office time and membership fees to sit on a charitable board. The SEC’s requirement of an independent consultant to review policies and controls emphasizes the SEC’s focus on companies having proper disclosure controls and procedures and training.
Integrally and Directly Related Standard
In the Dow case the SEC alleged that Dow applied the incorrect standard in determining whether an item is a perk. In determining whether an item is a disclosable perk, the SEC applies a two-step analysis (see Securities and Exchange Commission, “Executive Compensation and Related Person Disclosure,” Release Nos. 33-8732A, 34-54302A, File No. S7-03-06 (Aug. 29, 2006), at 74) (emphasis added):
- An item is not a perquisite or personal benefit if it 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.
If an item is "integrally and directly" related that ends the analysis. For example, a car used for business travel, regardless of the type of car, would not generally be a perquisite because the car is both integral and directly related to the performance of the executive’s duties. The business purpose test applied by Dow was originally considered by the SEC but ultimately not adopted in 2006. The integrally and directly related standard is a stricter threshold.
Complaint Involving Energy XXI
The Energy XXI case focused on the conduct of the company’s former CEO, John Schiller Jr. That case involved undisclosed perks, including a private bar stocked with liquor and cigars, personal use of company aircraft and shopping trips, among others. The SEC also accused Mr. Schiller of financing “an extravagant lifestyle” by intermingling his personal finances with company finances, leading to a failure to report related person transactions, including loans from vendors and a prospective board member. Although the company did not appear to have knowledge of the loans, the SEC did note that a director and officer (“D&O”) questionnaire was not timely completed.
Company Disclosure Controls
Recent SEC cases reinforce the need for robust controls and procedures to ensure proper evaluation and disclosure of perks. Proper procedures help reduce the likelihood of a disclosure issue but also may help reduce the severity of any penalty for an improper disclosure. Recent cases emphasize the need for focus and training about the “integrally and directly related” standard and the importance of timely completion of D&O questionnaires or other controls that would identify issues concerning perks.
As we have noted previously, other controls or training areas that may be considered include:
- tracking personal use of company assets (such as tickets for entertainment events);
- developing a methodology for calculating the aggregate incremental cost of perks;
- ensuring that the compensation committee approves all aspects of compensation, including perks;
- implementing a requirement to pre-approve perks and utilize a cost limit; and
- ensuring that an internal or external audit team reviews the company’s proxy disclosures and underlying support documentation.
For more information on recent perk cases and more detail on potential controls for companies to consider see our article from February 2018, here.