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We continue to pick up lessons from the SEC’s year-end enforcement activity. This Ropes & Gray memo flags a securities fraud action in which the Enforcement Division went beyond simply charging the company’s former CEO and CFO – they also went after the former Audit Committee Chair! Here’s the SEC announcement, the complaint against the CEO and the complaint against the CFO and Audit Committee Chair.

The Ropes memo summarizes the complaints, which are premised on allegations of improper revenue recognition that affected financial statements used in an IPO and follow-on offering. Here’s an excerpt:

According to the complaint against the CFO and AC Chair, the CFO and AC Chair first learned that the beta tests had not been performed on the day Kubient launched the follow-on offering. The SEC alleges that on that day an employee who had discovered that KAI had not scanned the customers’ data informed the AC Chair of this discovery, while questioning whether it could be indicative of fraud and suggesting that, if the wrong data had been scanned for the beta test, the company might need to restate its earnings. The AC Chair then relayed this information to the CFO on the same day.

The complaint further alleges that, despite learning this, neither the CFO nor the AC Chair investigated the circumstances of the $1.3 million revenue recognition; instead they both furthered the CEO-initiated fraudulent scheme by failing to correct the statements in the follow-on offering documents, signing the company’s subsequent public filings including the same statements, and lying to the company’s independent auditor about the revenue and their knowledge of concerns raised internally about the transactions supporting the revenue.

The memo goes on to detail the allegations against the Audit Committee Chair specifically, which included:

– Failing to investigate the circumstances surrounding the $1.3 million revenue recognition after learning that the customers’ data were not scanned by KAI;

– Failing to inform the independent auditor of that discovery;

– Failing to correct the KAI testing and revenue statements in the follow-on offering documents;

– Excluding the independent auditor from the audit committee meeting where concerns about the KAI contract were discussed (the “KAI Audit Committee Meeting”);

– Further concealing the KAI Audit Committee Meeting from the independent auditor by signing minutes (prepared by the CFO) of the immediately following audit committee meeting that disclosed another meeting, instead of the KAI Audit Committee Meeting, as the last audit committee meeting;

– Falsely stating to the auditor, during the 2020 year-end audit interview, that she was unaware of any tips or complaints regarding the company’s financial reporting, any fraud or suspected fraud affecting the company, or any other matters relevant to the audit; and

– Signing the company’s 2020 Form 10-K that included the statements in question.

Charges against audit committee chairs are rare, but statements from SEC officials about the important role of gatekeepers are not. Although there appear to have been some “bad facts” here, the charges reinforce the message that gatekeepers must take their role seriously, promptly investigate red flags, and oversee steps to correct material errors.

– Liz Dunshee