On March 12, 2019, the Securities and Exchange Commission announced it charged Lumber Liquidators Holdings Inc. with securities fraud for making fraudulent misstatements to investors.

The charges illustrate the perennial danger of misleading filings and highlight the SEC’s scrutiny over responses to negative press. In light of this enforcement, the consequences of hastily — or fraudulently — countering negative news may often be worse than news itself.

In March 2015, the CBS show 60 Minutes aired an undercover exposé claiming Lumber Liquidators was selling laminate flooring with excessive levels of formaldehyde. As a result, the company’s share price plummeted 20 percent during after-hours trading. Under pressure to mitigate the reputational damage caused by the program, Lumber Liquidators issued a press release the next day, submitted to the SEC as a Form 8-K, stating, among other things, that it had documentation proving its lumber met formaldehyde emissions standards. The company also stated in an earlier filling that it discontinued sourcing materials from non-compliant suppliers.

Some of these statements were false, while others misleadingly omitted key facts. On the same day it issued its press release, Lumber Liquidators placed new purchase orders from the same Chinese supplier the company’s executives knew had previously failed the formaldehyde emissions testing. The press release also misleadingly failed to disclose that this supplier had numerous record-keeping discrepancies and provided inconsistent documentation, casting doubt on the company’s claim that its documentation proved its lumber met formaldehyde emissions standards.

The SEC charged Lumber Liquidators with violating Rule 10b-5, which prohibits a company from making false statements or misleading omissions of material fact in connection with the purchase or sale of any security. The company was also charged with violating SEC Rules 12b-20, 13a-1, and 13a-11 for material misstatements in its 10-K and 8-K filings. According to the SEC, Lumber Liquidators’ false and misleading statements permitted the company to continue selling and sourcing the non-compliant product from China until May of 2015, resulting in increased profits and cost reductions by approximately $6 million. Lumber Liquidators ultimately agreed to pay disgorgement of over $6 million. Compounding the company’s troubles, the Department of Justice opened a parallel criminal investigation into the matter, and Lumber Liquidators also agreed to pay a $27 million criminal penalty — more than four times the disgorgement it paid in the SEC investigation.

Of course, there is danger in concealing the bad news altogether. In April 2018, the company formerly known as Yahoo! Inc. failed to disclose a giant data breach where Russian hackers stole the company’s usernames, email addresses, phone numbers, birthdates, encrypted passwords and security questions and answers. Fearing the media firestorm that would follow, Yahoo! concealed this information for two years. The company was charged with several counts of securities fraud and agreed to pay the SEC $35 million.

Even outside traditional press releases, other hasty public statements can also catch the SEC’s ire. In November 2018, professional boxer Floyd “Money” Mayweather Jr. agreed to pay the SEC fines and disgorgement for promoting cryptocurrencies on his personal Twitter and Instagram accounts — without disclosing that he was a paid promoter. Because the coins in question were deemed “securities” under the Howey test, Mayweather’s tweets came within the purview of the SEC and the Federal Securities laws. Mayweather was paid $300,000 for these tweets and grams, all of which he handed over to the SEC in disgorgement. He also agreed to pay the SEC an additional $300,000 penalty. The SEC’s Enforcement Division Co-Director Steven Peiken cautioned that “Social media influencers are often paid promoters, not investment professionals, and the securities they’re touting, regardless of whether they are issued using traditional certificates or on the blockchain, could be frauds.”

Takeaways

The SEC is charged with protecting the investing public, and its Enforcement Division reads the same media reports as the public to identify potential misstatements. Accordingly, responses to those reports can attract the agency’s attention. The agency is also actively increasing its monitoring of social media, hiring a software developer to create a “social media monitoring tool” to alert SEC staffers for targeted posts on sites “including but not limited to Facebook, Twitter, Instagram, YouTube, Google+, and LinkedIn.” This means officers and directors, even those much less prominent than Mayweather, should be wary of what they post online and how they respond to negative press. Considering the risks and potential costs of parallel criminal proceedings, publicly traded companies and their executives should practice restraint before making any public statement. Before making any material messages to the media, companies should vigilantly vet statements with counsel experienced in this area.