The U.S. Securities and Exchange Commission announced on July 2, 2018, that The Dow Chemical Company had agreed to a cease and desist order and to pay a $1.75 million penalty for failing to disclose certain expenses as executive perquisites (perks). In addition to the penalty, the SEC is requiring Dow to retain an independent consultant to review and revise its policies and employee training for identifying expenses that must be disclosed as perks under SEC rules. Although historically the SEC has brought few enforcement actions in this area, recent years have seen a spate of cases targeting companies—and sometimes individuals at companies— for failing to properly disclose executive perks. As whistleblower claims to the SEC continue to increase, the risk of drawing SEC enforcement scrutiny is also increasing.
SEC Findings: Issuers Must Use the “Integrally and Directly Related” Standard
Reuters reported that the SEC’s investigation began after a former Dow employee filed a whistleblower claim in 2014. According to the SEC order, Dow failed to disclose approximately $3 million in executive perks in its proxy statements from 2011 through 2015. Item 402 Regulation S-K of the Securities Exchange Act of 1934 requires issuers to disclose the total value (and identify by type) all perquisites and other personal benefits provided to named executive officers who receive at least $10,000 worth of such items in a given year. Item 402(c)(2)(ix)(A) also requires identification of all perks and personal benefits by type, and quantification of any perk/personal benefit which exceeds the greater of $25,000 or 10% of total perks (for purposes of the forgoing, “value” is determined by aggregate incremental cost to the company). The SEC found that Dow’s failure to correctly disclose executive perks violated Exchange Act Rule 14a-9, which prohibits the use of proxy statements containing materially false or misleading statements or materially misleading omissions.
Although Dow had procedures in place to evaluate whether executive expenses required disclosure as perks, the SEC concluded that Dow did not follow established SEC guidance for what qualifies as a disclosable perk. In the SEC’s 2006 release adopting the executive compensation reporting rules (Adopting Release), the SEC provided guidance on the proper standard issuers should use to judge what was a disclosable perk:
- An item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties.
- 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.
Dow incorrectly excluded as perks any expenses with a “business purpose” related to the executive’s job. Noting that the above standard is narrower, the SEC found that Dow failed to disclose numerous expenses as “other compensation,” including “travel to outside board meetings, sporting events, and personal activities; club memberships; limited use of personal assistant office time; and membership fees to sit on the board of a charitable organization.”
The SEC also concluded that Dow did not adequately train employees to apply the proper standard for perk disclosure, specifically employees drafting the Compensation Discussion and Analysis portion of the proxy statement and compiling the associated “Summary Compensation Table.”
In settling the matter, Dow neither admitted nor denied the SEC’s findings.
Key Takeaways
- The SEC’s “integrally and directly related” standard is much more narrow than the “business purpose” standard. The fact that an expense qualifies as an “ordinary” or “necessary” business expense for tax or other purposes does not determine whether the expense is a perk requiring disclosure under securities laws. The 2006 Adopting Release states that the “integrally and directly related” standard requires a distinction between items that executives need to do their job and items provided for some other reason, even if that other reason involves both personal and company benefit.
- Companies should ensure that all elements of processes and procedures for executive perk reporting follow SEC disclosure rules. The SEC criticized Dow’s Summary Compensation Table compilation process because Dow personnel compiled the data from various sources without ensuring that the reported amounts complied with SEC rules. Once adequate processes and procedures are put in place, companies should monitor that they are being correctly applied.
- Companies should adequately train employees to apply proper SEC disclosure standards. In particular, the SEC highlighted the need to adequately train employees tasked with compiling the Summary Compensation Table and drafting the Compensation Discussion and Analysis section of the proxy statement.
We will continue to follow this development as more analysis of the SEC enforcement action becomes available. For more information about Item 402 perquisite disclosure, please contact Michael Dicke or Scott Spector at Fenwick & West.
*Jordan Bradford-Shivers is a summer associate in Fenwick's corporate group.