Court: Court of Appeals for the D.C. Circuit; September 29, 2017; Federal Appellate Court
The Securities and Exchange Commission (SEC) has initiated legal action against RPM International, Inc. and its General Counsel and Chief Compliance Officer, Edward W. Moore, for alleged securities violations under the Securities Act of 1933 and the Securities Exchange Act of 1934. The SEC claims that the defendants fraudulently omitted loss contingencies in RPM's SEC filings while being aware of an ongoing qui tam action against RPM under the False Claims Act and an investigation by the Department of Justice (DOJ). This omission occurred even during settlement negotiations with the DOJ.
The SEC's objectives include enjoining RPM and Moore from further violations, disgorging any ill-gotten gains, and imposing civil penalties. RPM has filed a motion to dismiss the claims, asserting that the SEC failed to demonstrate that its financial statements were false, as accounting rules do not mandate the disclosure of preliminary settlement offers. RPM also argues the complaint lacks sufficient allegations regarding the materiality of the misstatements and challenges the validity of claims related to statements made after October 2012.
Moore has separately moved to dismiss the claims against him, contending the SEC has not adequately shown that accounting rules required prior accrual or disclosure of the potential loss related to the government investigation, nor that he personally benefited from RPM's alleged late accrual or disclosure. The SEC opposed both motions, and after reviewing the allegations favorably towards the SEC, the court found sufficient grounds for the fraud claims to proceed against both defendants.
RPM is based in Medina, Ohio, and manufactures various chemical products. Moore has served as RPM's General Counsel since 2007 and became Chief Compliance Officer in 2011. The current case originates from a qui tam lawsuit filed in July 2010 by a former employee of RPM's subsidiary, Tremco, Inc., alleging overcharging under government contracts.
The Department of Justice (DOJ) initiated an investigation into allegations made in a complaint to determine whether to intervene in a lawsuit. RPM became aware of this investigation in March 2011 when it received a subpoena for documents related to its and Tremco's government contracts. Moore managed the responses to the DOJ investigation and kept senior RPM officials informed, while also hiring outside counsel for representation. During RPM's quarterly Audit Committee meeting on April 5, 2011, Moore discussed the investigation, and the outside audit firm requested updates each quarter.
In the first quarter of fiscal year 2013, an email from the audit firm on June 7, 2012, suggested language for disclosing government investigations in a Form 10-K to be filed with the SEC in July, but RPM and Moore chose not to disclose the DOJ investigation. On August 9, 2012, the DOJ provided RPM with a copy of the qui tam complaint, which had been partially unsealed. Despite this, Moore did not inform the audit firm about the complaint.
In the second quarter of fiscal year 2013, RPM's outside counsel met with the DOJ on September 12, 2012, and discussed a consultant's analysis estimating that Tremco had overcharged the government by at least $11 million. The SEC claims Moore was informed of this discussion. On September 28, 2012, during an audit review, when asked about the DOJ investigation, Moore downplayed the situation, stating that no claims had been asserted. He later sent a management representation letter claiming there had been no substantive attention to material loss contingencies exceeding $1.2 million.
On October 1, 2012, RPM submitted an analysis to the DOJ estimating that Tremco overcharged the government by approximately $11.4 million. However, during the subsequent Audit Committee meeting, Moore did not disclose this estimate. The Chairman of the Audit Committee expressed concerns about ongoing extraordinary charges impacting the company's shareholder perception. The $11.4 million estimate represented about 30% of RPM's net income for the quarter. RPM later filed Form 8-K and Form 10-Q documents, neither of which disclosed the DOJ investigation, though the Form 10-Q broadly referred to various claims and lawsuits. The SEC alleges that the Form 10-Q falsely claimed that RPM's disclosure controls were effective.
On October 19, 2012, RPM filed a $300 million notes offering Prospectus Supplement with the SEC, incorporating prior SEC filings. The notes offering closed around October 23, 2012. On November 5, 2012, the DOJ informed RPM that the seal on a qui tam complaint would expire on January 17, 2013, prompting RPM to prepare a settlement offer. By December 14, 2012, RPM estimated that Tremco had overcharged the government by at least $11.9 million, and Moore, aware of the DOJ's typical settlement multiplication for FCA cases, anticipated an increasing settlement amount. RPM planned to submit a settlement offer by January 11, 2013, and by December 21, 2012, outside counsel estimated RPM's exposure at $27-28 million.
A week later, Moore sent a management representation letter to the audit firm, asserting no significant loss contingencies over $1.2 million, despite the ongoing DOJ investigation. The SEC alleges that during an Audit Committee meeting on January 4, 2013, Moore failed to disclose the overcharge estimates, the planned settlement offer, and the increasing estimated settlement figure. Prior to filing RPM's Form 8-K and Form 10-Q on January 8, 2013, Moore did not communicate the qui tam complaint to the audit firm, only indicating a potential loss of approximately $5 million. It was not until January 10, 2013, that Moore informed the CEO of a potential loss of $28 million.
On January 11, 2013, RPM submitted a settlement proposal of $28.3 million to the DOJ, which countered with a $71 million offer on March 29, 2013. Subsequently, RPM accrued a $68.8 million liability for this investigation on April 1, 2013, publicly disclosing it in its third quarter filings on April 4, 2013, which reported a net loss of $42.2 million. The SEC contends these filings misleadingly indicated timely disclosure and accrual for the DOJ investigation, despite the qui tam complaint still being under seal at that time.
The SEC alleges that RPM's audit firm met with Ed Moore on June 10, 2013, to discuss RPM's accrual for a DOJ investigation. Moore reportedly misled the audit firm by stating that RPM made a settlement offer after filing its Form 10-Q on January 8, 2013, while the SEC claims RPM had communicated this offer as early as December 19, 2012. Additionally, Moore failed to disclose that the overcharge estimates had reached $27-28 million prior to the Form 10-Q filing. RPM's subsequent Form 10-K, filed on July 24, 2013, disclosed the DOJ investigation but misleadingly suggested that necessary disclosures and accruals were timely when they should have been made in the earlier quarters. The Form 10-K also failed to acknowledge any material weaknesses in internal financial controls.
In July 2013, RPM awarded Moore a $300,000 cash bonus based in part on financial performance, while in August, RPM settled the DOJ investigation for approximately $61 million. A Prospectus Supplement for a $200 million notes offering was filed on December 5, 2013, which the SEC alleges included RPM's misleading filings. On April 8, 2014, during discussions regarding a Form S-3 registration statement, Moore allegedly misrepresented the range of possible losses related to the DOJ investigation.
Subsequently, RPM provided the SEC with a written chronology stating that a settlement proposal would be submitted by January 11, 2013, which Moore reviewed and authorized. In July 2014, RPM paid Moore a $400,000 bonus tied to financial performance, which was enhanced by the notes offering. An investigation conducted by independent counsel later revealed that by late December 2012, Moore was aware that RPM's financial exposure was expected to increase significantly and that he failed to disclose critical information to the audit committee or the audit firm during a meeting on January 4, 2013.
The Audit Committee instructed RPM to restate its financial statements for the first three quarters of fiscal year 2013, specifically by accruing liabilities of $11.4 million and $16.9 million for the first and second quarters, respectively, and decreasing the third quarter accrual by $28.3 million from $68.8 million, totaling a restatement of $40.5 million. On August 14, 2014, RPM filed a Form 8-K admitting to errors in disclosing and accruing for a Department of Justice investigation, along with amended Form 10-Qs for each quarter of fiscal year 2013. The SEC alleges that these errors were material, necessitating the restatement.
The SEC's complaint includes seven claims:
1. RPM and Moore are accused of making false and misleading statements in various filings, violating Section 17(a)(2) of the Securities Act.
2. They allegedly engaged in fraudulent conduct towards securities purchasers, violating Section 17(a)(3) of the Securities Act.
3. RPM is claimed to have made inaccurate statements in filings, violating Section 13(a) of the Exchange Act and related rules.
4. RPM purportedly failed to maintain accurate books and records, violating Section 13(b)(2)(A) of the Exchange Act.
5. RPM is alleged to have not maintained a proper system of internal accounting controls, violating Section 13(b)(2)(B) of the Exchange Act.
6. Moore is accused of falsifying RPM's records, violating Exchange Act Rule 13b2-1.
7. Moore allegedly made false statements to accountants regarding RPM's financial statements, violating Exchange Act Rule 13b2-2(a).
The document also outlines the standard of review for a Rule 12(b)(6) motion to dismiss, emphasizing that a complaint must present sufficient factual matter to state a plausible claim for relief, as established by Supreme Court rulings. A claim is plausible when it allows a reasonable inference of the defendant's liability, requiring more than just mere possibilities or conclusory statements.
In considering a motion to dismiss under Rule 12(b)(6), the Court must interpret the complaint liberally in favor of the plaintiff, granting all reasonable inferences from the facts alleged. However, the Court is not obligated to accept inferences that lack factual support or the plaintiff's legal conclusions. In evaluating such motions, courts may only consider the allegations in the complaint, attached documents, or facts subject to judicial notice.
Federal Rule of Civil Procedure 9(b) imposes heightened pleading standards for fraud claims, requiring plaintiffs to specify the circumstances of the fraud or mistake. While intent and knowledge can be stated generally, the specifics such as time, place, and content of false representations must be detailed to satisfy Rule 9(b). This standard applies to misrepresentation claims under Section 10(b) of the Exchange Act, and most circuits extend it to claims under the Securities Act if they involve allegations of fraud, even if negligence suffices for the claim. However, the Eighth Circuit has ruled that Rule 9(b) does not apply to Section 11 claims, as proving fraud is not necessary for liability under that section. The D.C. Circuit has not definitively ruled on this issue, but district courts within D.C. have required adherence to Rule 9(b) for Securities Act violations.
Claims under Section 17(a)(2) and 17(a)(3) of the Securities Act necessitate allegations of negligence and must satisfy Rule 9(b)'s heightened pleading standard, as established in case law, including SEC v. Wey and SEC v. Thompson. The SEC's action hinges on allegations of fraud, which the agency does not contest in applying Rule 9(b). Consequently, the court will apply this heightened standard to evaluate the motions to dismiss the claims under Section 17, while claims based on Section 13 of the Exchange Act will adhere to the traditional Rule 12(b)(6) standard.
The SEC has sufficiently stated a claim against RPM and Moore under Section 17(a)(2). This section prohibits obtaining money through false statements or omissions during the sale of securities. To succeed, the SEC must demonstrate that the defendants engaged in the sale, made material misrepresentations or omissions, and obtained funds through these misdeeds. Notably, negligence suffices for liability under Section 17(a)(2); there is no requirement to prove knowledge of wrongdoing.
The SEC alleges that RPM and Moore made misleading statements in nine SEC filings from October 2012 to December 2013. Specifically, in October 2012, the SEC contends that the defendants failed to disclose a loss contingency related to a qui tam complaint and a DOJ investigation into overcharging the government. The SEC claims that RPM's Form 8-K and Form 10-Q filings during this period failed to mention the DOJ investigation, rendering them false and misleading.
The Form 10-Q contained a 'Contingencies' section indicating that the company faced various claims and lawsuits typical of its business operations. It stated that while the exact liabilities are unpredictable, provisions are recorded when deemed probable and estimable, based on historical data and legal counsel. These provisions are reviewed quarterly and may adjust with new developments. The accruals capture estimated losses, influenced by potential actions from third parties like regulators and courts. The company acknowledged that while additional liabilities could materially impact short-term financial results, they did not anticipate a long-term adverse effect on operations or liquidity.
The SEC alleges that RPM failed to disclose a Department of Justice (DOJ) investigation, rendering the 'Contingencies' discussion misleading, given that a material loss was likely and ascertainable by October 4, 2012. The Form 10-Q also included a 'Controls and Procedures' section where the CEO and CFO asserted their disclosure controls were effective. The SEC contests this assertion, citing a later admission by RPM regarding ineffective controls at the end of the first quarter.
On October 19, 2012, RPM filed a Prospectus Supplement for a $300 million notes offering, which incorporated previous SEC filings. The SEC claims this document was also misleading due to the alleged omissions in those filings. Additionally, two SEC filings in January 2013 are identified as false and misleading for not disclosing or accruing the ongoing DOJ investigation. By early January 2013, RPM was reportedly aware of a settlement offer to the DOJ amounting to approximately $27-28 million.
On January 8, 2013, RPM submitted a Form 8-K and a Form 10-Q for the second fiscal quarter, reiterating statements from similar filings in October 2012, which the SEC challenges for identical reasons. The April 4, 2013 filings also faced SEC allegations of being false and misleading. Specifically, the Form 8-K disclosed a $68.8 million accrual linked to an investigation by the DOJ concerning the Company's Building Solutions Group roofing contracts with the GSA, indicating ongoing settlement discussions and cooperation with the investigation. The Form 10-Q similarly detailed the accrual, asserting cooperation with the DOJ and GSA regarding pricing compliance, while acknowledging that the actual loss could differ from the recorded accrual.
Despite publicly disclosing the DOJ investigation and accrual for the first time, the SEC contends that these filings misleadingly suggested that RPM had promptly disclosed and accrued for the investigation, asserting that the entire accrual was wrongly recorded in the third quarter instead of in the first and second quarters as per GAAP requirements. The SEC further alleges that RPM's Form 10-K for fiscal year 2013 contained similar misleading assertions regarding timely disclosure and effective internal controls. Additionally, RPM was accused of filing a misleading Prospectus Supplement on December 5, 2013, related to a $200 million notes offering.
The SEC claims that the Prospectus Supplement, which incorporated a Form 10-K and other SEC filings by RPM, is misleading due to the omission of information regarding a Department of Justice (DOJ) investigation. RPM and Moore seek to dismiss the SEC's Section 17(a)(2) claim, arguing they had no duty to disclose or account for the DOJ investigation, and asserting that the alleged omissions were not material, constituted opinion statements without knowledge of their falsity, and did not occur during the offer or sale of securities. Moore specifically contends that the SEC has not shown he profited from any untrue statements or omissions.
The SEC asserts that defendants had a duty to disclose and accrue for the DOJ investigation before the April 2013 filings. Section 17(a)(2) prohibits obtaining money or property through untrue statements or material omissions that render other statements misleading. The defendants argue that the claim fails due to a lack of duty to disclose omitted information. While the D.C. Circuit has not specifically addressed omissions under Section 17(a), courts have interpreted it in conjunction with Section 10(b) and Rule 10b-5, which share similar language. The Supreme Court has ruled that nondisclosure alone cannot constitute fraud without a duty to disclose. The D.C. Circuit has further clarified that a duty arises not only from specific regulations but also when silence would render other statements misleading.
The Court concludes that the SEC has presented sufficient facts to support the assertion that RPM and Moore had a duty to disclose the DOJ investigation in accordance with accounting standards.
The SEC cites Generally Accepted Accounting Principles (GAAP) and specifically Accounting Standards Codification (ASC) 450 as the basis for the duty to disclose loss contingencies. The SEC asserts that from March 2011 to April 2013, the Department of Justice (DOJ) investigation constituted a loss contingency that should have been accrued or disclosed. Defendants argue against this obligation under ASC 450. Financial statements filed with the SEC must adhere to GAAP, and those that do not are deemed misleading. ASC 450 outlines the criteria for accruing and disclosing loss contingencies, defined as uncertain conditions that may lead to a loss. Loss contingencies include actual or potential claims and pending or threatened litigation.
The SEC claims the DOJ investigation represented a reasonably possible loss for RPM, necessitating disclosure and accrual due to the likelihood of loss being probable and estimable. ASC 450-20-50 mandates that for asserted claims, disclosure is required if there is at least a reasonable possibility of loss. A "reasonably possible" loss is defined as more than remote but less than likely. For unasserted claims, disclosure is only necessary if it is probable that a claim will be made and there is a reasonable chance of an unfavorable outcome. If the likelihood of claim assertion is not probable, no accrual or disclosure is required. However, should an unfavorable outcome be probable and the loss quantifiable, accrual is mandated. ASC 450 also specifies factors to assess the probability of an unfavorable outcome in litigation or claims.
Key points of the excerpt include the following:
1. The litigation assessment requires consideration of the nature of the claim, case progress, legal opinions, and the experiences of both the entity and others in similar situations. Management's decisions on responding to lawsuits, whether to contest or settle, are also relevant.
2. Under ASC 450, an issuer must record a loss contingency if an unfavorable outcome is probable and the loss can be reasonably estimated. However, merely filing a lawsuit does not automatically necessitate loss accrual.
3. The SEC alleges that RPM had a duty to disclose and accrue for a DOJ investigation in its October 2012 filings. It is crucial to determine if the investigation was an "asserted" or "unasserted" claim under ASC 450 to evaluate any breach of disclosure duty.
4. RPM and Moore were aware of a whistleblower qui tam complaint by at least August 9, 2012. Moore argues the claim was "unasserted" at that time, as the government had not indicated its intention to intervene.
5. Moore contends that the SEC needed to prove it was probable that a claim would be asserted and that an unfavorable outcome was reasonably possible; without these allegations, there was no duty to disclose.
6. The SEC maintains that a claim was asserted due to the existing qui tam complaint. Even as an "unasserted" claim, the SEC argues that the DOJ's awareness of a possible claim negates the need for the higher probability standard.
7. The Court agrees with the SEC, acknowledging that the qui tam action was filed in July 2010, and RPM and Moore were aware of the ongoing investigation by the DOJ. The Court concludes that disclosure obligations under ASC 450 apply due to the DOJ's engagement with RPM regarding overpayment issues.
ASC 450 lacks clarity on what constitutes "manifest" awareness of a potential claim. Moore cites *In re Lions Gate Entertainment Corp. Securities Litigation* to argue that a government agency's investigation alone does not equate to "manifested awareness." In that case, the court dismissed the complaint, ruling that an SEC investigation did not trigger a duty to disclose or accrue under ASC 450, as it did not represent "pending or threatened litigation" and the settlement amount was unknown until later.
However, unlike *Lions Gate*, RPM and Moore were aware of a pending federal civil complaint related to the False Claims Act, which indicates a higher level of awareness. The SEC complaint states that by September 2012, RPM was assessing the potential financial implications of overcharges to the government, which could lead to substantial liability. This situation is more comparable to *Indiana Public Retirement System v. SAIC, Inc.*, where the defendant failed to disclose a significant potential liability related to a kickback scheme in its Form 10-K. The court found that the city’s awareness of a potential claim established a violation of Financial Accounting Standard No. 5, which preceded ASC 450.
To establish a claim under ASC 450, the SEC must demonstrate a "reasonable possibility" of loss, which it claims exists, asserting that defendants had knowledge of a material loss risk tied to the DOJ investigation.
Tremco allegedly overcharged the government by at least $11.4 million, a fact known to RPM, which communicated this estimate to the DOJ. RPM contends it was not required to disclose or accrue for the DOJ investigation under ASC 450, arguing that the guidelines do not mandate disclosure of settlement offers. However, the SEC's complaint asserts that RPM had a duty to disclose the DOJ investigation as a loss contingency based on knowledge prior to April 2013, including the potential settlement offer that ASC 450 recognizes as relevant for determining the necessity of disclosure or accrual.
Moore argues that the loss was not "probable" at the time of RPM's October 2012 filings, as the government had not indicated an intention to intervene in the qui tam action, and claims the SEC must allege that he knew RPM was likely to settle or lose. Nonetheless, the SEC’s allegations—claiming that RPM "knew or should have known" of a probable and estimable loss—are deemed sufficient to survive a motion to dismiss. The SEC argues that defendants were aware of the qui tam complaint, the $11.4 million liability estimate, and ongoing settlement discussions, supporting the inference of a probable loss.
For the January 2013 filings, the SEC also claims defendants had a duty to disclose and accrue for the DOJ investigation, given new information that emerged by January 8, 2013. By November 2012, RPM learned that a settlement was expected by mid-January and indicated to the DOJ it would submit a settlement offer by January 11, 2013. RPM representatives, including Moore, discussed a planned settlement amounting to $27-28 million, ultimately submitting a proposal for $28.3 million on January 11, 2013. The SEC alleges that RPM violated ASC 450 in both the October 2012 and January 2013 filings by failing to disclose and accrue for the loss contingencies related to the DOJ investigation.
As of January 8, 2013, the SEC alleged that RPM was obligated to disclose a Department of Justice (DOJ) investigation due to the reasonable possibility of a loss, which became probable when RPM prepared a settlement agreement involving over $20 million. RPM had indicated a potential liability of $28.3 million in its settlement offer, suggesting that both RPM and its representative, Moore, were aware of the likelihood of a settlement and loss. Consequently, the SEC asserted that RPM violated ASC 450 by failing to disclose and accrue for this loss in its filings.
The SEC successfully alleged that any misstatements or omissions made by the defendants were material, as defined under federal securities laws, meaning there was a substantial likelihood that a reasonable investor would find such information important. Materiality must be assessed at the time of the contested transaction, and courts are generally reluctant to dismiss claims of materiality unless the omitted information is clearly unimportant. The issuance of a financial restatement, which indicates material errors, is also considered sufficient to demonstrate materiality in legal contexts.
Restatement of financial statements under Generally Accepted Accounting Principles (GAAP) is mandated only to rectify material accounting errors present at the time of their issuance. Materiality is suggested by allegations that a decision impacts more than five percent of total assets, as noted in case law, with a five percent threshold serving as a guideline. RPM contends that the alleged misstatements and omissions are immaterial due to their negligible effect on RPM's stock price following disclosures related to a Department of Justice investigation and a subsequent financial restatement. While some courts have ruled that immateriality can be established by a lack of stock price impact after public disclosures, others reject this view, emphasizing the "reasonable investor" standard for materiality established in Supreme Court precedent. The D.C. Circuit has maintained that materiality does not necessitate proof of actual investor harm. The court, considering all factual allegations as true at this motion to dismiss stage, finds it premature to dismiss the case for failure to plead materiality. RPM's admission of errors in its financial statements and the SEC's assertion that the misstatements were material—citing a significant overcharge estimate relative to RPM's net income—further support this position.
The court cannot definitively determine the materiality of RPM's misstatements or omissions regarding a DOJ investigation and internal controls at this stage, as reasonable investors may find these details significant. RPM contends that its SEC filings for fiscal 2013 reflect subjective opinions based on accounting standards, and thus cannot be false or misleading. However, the SEC argues that these statements are misleading due to omissions and that sufficient facts have been presented to support this claim. The misstatements are found in RPM's Form 10-Q filings from October 4, 2012, and January 8, 2013, which discuss various claims, recording provisions for potential liabilities, and the estimation of loss provisions based on historical experience and legal advice. RPM asserts that while excess liabilities could affect short-term results, they do not believe these would materially impact long-term operations or financial position. Both parties reference the Supreme Court's decision in **Omnicare Inc. v. Laborers District Council Construction Industry Pension Fund** as relevant to the case.
The Supreme Court addressed whether a company's statements regarding compliance with legal standards in a registration statement could breach Section 11 of the Securities Act, which allows for issuer liability based on both affirmations and omissions in the statement. The case involved two opinion statements from Omnicare asserting compliance with federal and state laws and the validity of its contracts. The Court clarified that while sincere opinions are not inherently false, Section 11 can be invoked for false statements if it is proven that the issuer knew the opinion was false. Since the plaintiff did not dispute the authenticity of Omnicare’s beliefs, the complaint failed to assert a false statement claim.
However, the Court emphasized that omissions can render an opinion misleading, even if the statement is literally true, thus allowing claims based on omissions related to opinions. It established that an ordinary investor's perspective is crucial in determining whether a statement is misleading. The terms "we believe" or "we think" can lead to misleading interpretations. The Court indicated that the omissions clause of Section 11 does not serve as a blanket disclosure requirement but allows claims when an issuer fails to disclose material facts that would make an opinion statement misleading. To establish such a claim, an investor must identify specific material facts regarding the issuer's investigation or knowledge that were omitted, which mislead a reasonable person reading the statement in context.
Applying the Omnicare ruling to a Section 17(a)(2) claim indicates that the SEC's complaint meets the objective standard. Allegations suggest that statements made by RPM were misleading due to omissions of critical information known to Moore and RPM. Key facts include:
- On August 9, 2012, Moore and RPM personnel reviewed a qui tam complaint but failed to disclose it to the audit firm.
- On September 12, 2012, RPM's outside counsel informed the DOJ, with Moore's knowledge, that Tremco overcharged the government by at least $11 million.
- On September 28, 2012, when questioned by the audit firm about the DOJ investigation, Moore misrepresented the status, claiming "no claim had been asserted."
- On October 1, 2012, Moore provided a management representation letter stating that neither he nor any supervised lawyers had addressed material loss contingencies exceeding $1.2 million, despite RPM estimating a $11.4 million overcharge to the DOJ that same day.
- During an October 2, 2012 Audit Committee meeting, Moore failed to disclose the $11.4 million overcharge estimate, despite a warning from the Committee Chairman about the implications of extraordinary charges on the company's reputation.
- Additional facts revealed include a December 14, 2012 analysis estimating the overcharge at $11.9 million and plans for a $27-28 million settlement discussed on December 21, 2012, all known to Moore.
- Moore again misrepresented the status of the DOJ investigation in a December 28, 2012 management representation letter, stating no significant loss contingencies existed.
These points illustrate a clear pattern of omission and misrepresentation by Moore and RPM leading up to their SEC filings.
During RPM's second quarterly meeting with its Audit Committee, Moore provided updates on the DOJ investigation but failed to disclose key information, including calculated overcharge estimates and a forthcoming settlement offer of $27-28 million by January 11, 2013. RPM maintains that its financial filings did not require such disclosures under GAAP or securities laws. However, the Court has previously noted that the omissions did not align with GAAP standards and that RPM's claims of belief or judgment were misleading, especially as crucial information was allegedly withheld from senior management and auditors. A reasonable investor would expect these parties to be fully informed before making any statements regarding loss contingencies in SEC filings. Consequently, the SEC has presented sufficient facts to support a claim under Section 17(a)(2), which encompasses fraud during the entire selling process of securities. RPM challenges the SEC's allegations, arguing they do not sufficiently link misstatements to the offer or sale of securities and that merely trading publicly is inadequate for this requirement. However, precedent supports that an allegation of a company's stock being publicly traded satisfies the "offer or sale" criterion. RPM cites one local case to argue against this, but it is neither binding nor directly applicable, as it lacked allegations of transactions during the relevant reporting period.
The SEC alleges that RPM, a publicly traded company, was involved in two notes offerings in October 2012 and December 2013, and that its common stock was registered with the SEC and traded on the New York Stock Exchange under the ticker 'RPM'. The SEC claims that RPM's filings contained false or misleading statements relating to the offer or sale of its securities. Specifically, the SEC contends that Moore obtained money or property in violation of Section 17(a)(2) of the Securities Act, which prohibits obtaining money through untrue statements of material fact.
Moore argues that the SEC's claim fails because it does not adequately show he obtained money through material misstatements. However, the court finds that allegations linking a company officer's bonuses to the company's performance are sufficient to support a claim under Section 17(a)(2). Previous cases demonstrate that bonuses tied to company performance can substantiate claims of obtaining money through fraudulent activities.
While the SEC establishes Moore's personal interest in RPM’s stock through his ownership of shares and options, it does not demonstrate how fluctuations in stock price affected his financial gains. Nonetheless, the SEC does allege that Moore received cash bonuses of $300,000 and $400,000 for the fiscal years ending May 31, 2013, and May 31, 2014, respectively. These bonuses were partially based on RPM's financial performance, which was influenced by the alleged misleading statements connected to the notes offerings. This information supports the SEC's claim that Moore obtained money through the material misstatements or omissions in RPM's filings.
The SEC has presented sufficient allegations suggesting that part of Moore's bonus was derived from false and misleading statements related to the company's financial performance, specifically tied to financial statements used in two notes offerings. The SEC must prove these allegations as the case progresses. The court denies the defendants' motions to dismiss Claim 1, confirming a claim under Section 17(a)(2) of the Securities Act.
Additionally, the SEC has established a claim against RPM and Moore under Section 17(a)(3), which prohibits engaging in transactions or practices that fraudulently affect purchasers during securities offers or sales. Similar to Section 17(a)(2), proof of negligence suffices for a violation. Section 17(a)(3) focuses on the impact of conduct on investors rather than the culpability of the individual responsible.
For a scheme liability claim under Section 17(a)(3), the alleged conduct must extend beyond the misrepresentations or omissions central to misstatement claims. Courts, including the Second and Ninth Circuits, have determined that scheme liability requires conduct that is not solely based on misrepresentations or omissions actionable under Rule 10b-5(b). A defendant can only be liable for participating in a fraudulent scheme if the scheme includes deceptive conduct beyond mere misrepresentations.
Liability under Sections 17(a)(2) and 17(a)(3) can arise from the same facts if the plaintiff alleges both misrepresentations and a deceptive course of conduct exceeding those misrepresentations. However, if the only claim against a defendant is participation in a scheme involving misleading statements, they cannot be held liable under subsection (3).
RPM contends that the SEC has not identified separate actions taken to further the alleged scheme beyond the purported misrepresentations or omissions. However, the SEC presents a narrative indicating that Moore actively engaged in efforts to conceal the existence of a qui tam complaint and a DOJ investigation, which extends beyond merely filing false or misleading statements. The SEC alleges that RPM and Moore possessed the qui tam complaint but did not disclose it to RPM's audit firm or Audit Committee. Additionally, Moore failed to inform the Audit Committee about significant potential liabilities, including an overcharge to the government of at least $11.4 million by Tremco, which he later knew had risen to approximately $27-28 million. Despite this knowledge, he continued to withhold information from auditors and the Audit Committee, even as he was aware RPM was calculating further overcharges. As of January 8, 2013, Moore only communicated a loss range of $5 million to RPM's audit firm regarding the DOJ investigation. The SEC claims sufficient grounds under Section 17(a)(3) and asserts claims against RPM under Section 13(a) of the Exchange Act and associated rules for failing to file complete and accurate reports. RPM's sole defense hinges on the assertion that any misrepresentations were immaterial; however, the court has already found that the SEC has plausibly alleged materially false and misleading statements. Consequently, the motions to dismiss Claims 2 and 3 are denied.
The SEC has raised a claim against RPM under Section 13(b)(2)(A) of the Exchange Act, asserting that RPM's financial records fail to accurately and fairly reflect its transactions and asset dispositions. This section mandates that all issuers maintain books and records in reasonable detail, following accepted reporting methods, and prohibits deliberate acts that lead to inaccurate financial reporting. The SEC contends that RPM's financial statements for the first three quarters of fiscal year 2013 were inaccurate: the first two quarters did not disclose or accrue for a Department of Justice (DOJ) investigation, while the third quarter understated the necessary accrual. Additionally, financial statements filed in July and December 2013 misleadingly suggested timely and accurate disclosures regarding the DOJ investigation and claimed effective internal controls. RPM has not presented substantial arguments against these allegations aside from claiming that its financial statements were not false. The Court has determined that the SEC has adequately alleged false and misleading statements in RPM's filings, leading to the conclusion that RPM's records did not meet the requirements of Section 13(b)(2)(A), resulting in the denial of RPM's motion to dismiss this claim. Furthermore, the SEC has also stated a claim under Section 13(b)(2)(B), which requires issuers to establish and maintain internal accounting controls that provide reasonable assurances that transactions are executed in accordance with management's authorization.
Transactions must be recorded to ensure financial statements comply with generally accepted accounting principles (GAAP) and to maintain asset accountability. Access to assets requires management authorization, and recorded asset accountability must be periodically compared with actual assets, with actions taken for discrepancies. A "reasonable" degree of assurance is defined as satisfying prudent officials. Internal controls include manual or automated record reviews for completeness and accuracy, thorough transaction recording, and reconciliations to detect errors.
The SEC alleges RPM had significant weaknesses in its internal controls related to financial reporting, which RPM acknowledged in a 2014 restatement. Specific issues included delayed and inaccurate information regarding a Department of Justice (DOJ) investigation, leading to non-compliance with GAAP in financial statements. The SEC claims that key RPM personnel, including Moore, possessed critical information without adequate internal oversight regarding its disclosure.
RPM's motion to dismiss Claim 5, arguing its financial statements were not false, has been rejected by the Court, which found the SEC's allegations plausible. Additionally, Claim 6 against Moore under Exchange Act Rule 13b2-1 alleges he falsified records, with no requirement for proof of scienter. Moore contends he did not violate the rule because the SEC failed to show he acted unreasonably in not disclosing a loss contingency. However, the Court finds the SEC has plausibly alleged that disclosure was required, rendering Moore's argument unconvincing.
Moore's involvement in communications with RPM's outside audit firm and his oversight of responses to the DOJ investigation raises allegations of his direct or indirect role in falsifying RPM's records. Consequently, the court denies Moore's motion to dismiss Claim 6. The SEC presents a valid claim against Moore under Exchange Act Rule 13b2-2(a) in Claim 7, which prohibits directors or officers from making materially false or misleading statements to accountants in connection with audits. Notably, proof of scienter is not required under this rule. Moore's defense, asserting that he did not mislead RPM's audit firm because outside counsel possessed the same information, is deemed irrelevant to the SEC's allegations of Moore's own misleading conduct. Specific allegations include Moore's false statements in management representation letters regarding loss contingencies and misleading verbal communications to auditors about ongoing investigations. The SEC's claims, taken as true, suggest Moore acted unreasonably in his auditor communications, thus violating Rule 13b2-2(a). Therefore, the motion to dismiss Claim 7 is also denied. The court concludes by rejecting all defendants' motions to dismiss entirely, noting that it may consider documents referenced in the complaint, including those provided by the defendants. The SEC acknowledges the use of additional documents in its opposition.
The law firm's audit response letter indicates that it has not been engaged to address or represent RPM in connection with loss contingencies exceeding $1,200,000, whether individually or in aggregate. It clarifies that investigations by government or self-regulatory authorities are not considered 'loss contingencies.' This letter mirrors the language from a previous letter and continues to identify RPM's outside counsel and the "Tremco Roofing Matter." The SEC's complaint references amended reports for the first and second quarters, but its opposition also discusses reports for all three quarters, providing them as exhibits. Public records, including SEC filings, can be judicially noticed by the Court, as established in prior cases. Courts have found that claims under Section 13 of the Exchange Act do not require the heightened pleading standard of Rule 9(b) since they do not necessarily sound in fraud. The excerpt also cites Rule 10b-5, which prohibits fraud and material misstatements in securities transactions. RPM's argument focuses on ASC 450 and does not address whether claims were "asserted" or "unasserted." The SEC further alleges violations of Item 303 of Regulation S-K.
RPM had a duty to disclose the Department of Justice (DOJ) investigation, supported by Rule 12b-20 and other legal standards. However, the Court's findings are based on the alleged violation of disclosure duties under ASC 450. Section 11 of the Securities Act allows individuals to sue if a registration statement contains misleading information or omits material facts, without needing to prove scienter, as established in Omnicare. While the D.C. Circuit has not ruled on the application of Omnicare to Section 17(a)(2), other courts have applied the Section 11 standards across various antifraud provisions, including Section 10(b) and Rule 10b-5. Case law generally treats claims under Section 17(a)(3) and Rule 10b-5(c) together, often applying similar standards, as evidenced by multiple court decisions that recognize their overlapping requirements.
