A Fortune 500 CFO admits to having deliberately treated $4 billion in operating expenses as assets, thereby allowing the corporation to show profits instead of losses. The auditor never detected this. The corporation’s stock drops 95 percent and bond covenants related to billions in debt are breached. At its peak price last year, the CFO sold stock (acquired through options) for $15 million, generating a $10 million gain.
a. Why might the corporation have to file for bankruptcy protection?
b. What provision(s) of the securities law will probably be the basis for a class-action lawsuit by the stockholders?
c. Why will the 1995 Act probably not stop a class-action lawsuit from proceeding to the discovery phase?
d. Why will the CFO be subject to criminal (as well as civil) securities sanctions?
e. Will the SEC likely ever allow the CFO to be an officer or director of a publicly traded corporation in the future?
f. Will the SEC allow the CFO to keep the $10 million gain on the stock?
g. What kind of civil penalties could the SEC impose on the CFO?
Will the SEC likely ever allow the CFO to be an officer or director of a publicly traded Corporation in the future?
a. The corporation might have to file for bankruptcy protection because the deliberate treatment of operating expenses as assets misrepresented its financial health. This led to a significant drop in its stock price and breached bond covenants, indicating financial instability and inability to meet its obligations.
To determine the exact reasons for bankruptcy, a thorough analysis of the corporation's financial statements, debt structure, and ability to pay its creditors would be necessary.
b. The class-action lawsuit by the stockholders could be based on provisions of securities law, such as:
- Section 10(b) of the Securities Exchange Act of 1934, which prohibits fraudulent activities in connection with the purchase or sale of securities.
- Rule 10b-5, promulgated under the Securities Exchange Act, which prohibits material misstatements or omissions of facts in connection with the purchase or sale of securities.
c. The 1995 Act, likely referring to the Private Securities Litigation Reform Act (PSLRA), may not stop a class-action lawsuit from proceeding to the discovery phase because the Act provides certain provisions that allow the lawsuit to move forward. The PSLRA sets criteria for bringing such lawsuits, including adequate pleading requirements, identification of misleading statements or actions, and a strong inference of scienter (intent to deceive).
d. The CFO may be subject to criminal securities sanctions in addition to civil penalties due to the serious nature of the misconduct. Key provisions of securities laws that may be relevant in this case include:
- Section 10(b) of the Securities Exchange Act of 1934, which makes it unlawful to use fraudulent practices in connection with the purchase or sale of securities.
- Rule 10b-5, which prohibits material misstatements or omissions of facts in connection with the purchase or sale of securities.
These provisions can lead to criminal charges for securities fraud or other related offenses.
e. The SEC is unlikely to allow the CFO to be an officer or director of a publicly traded corporation in the future, considering the gravity of the financial misconduct committed. The CFO's actions in deliberately misrepresenting financial information, leading to significant losses for investors, indicate a lack of integrity and raise concerns about their suitability for such positions.
f. It is unlikely that the SEC will allow the CFO to keep the $10 million gain on the stock since it was generated through fraudulent activities. The SEC may take steps to recover ill-gotten gains and impose penalties as part of its enforcement actions.
g. The SEC has the authority to impose civil penalties on the CFO for securities violations. The specific civil penalties can vary based on the severity and nature of the violations but may include monetary fines, disgorgement of ill-gotten gains, and prohibition from serving as an officer or director of a public company. The amount of civil penalties would be determined through legal proceedings, taking into account factors such as the scale of the fraud and the CFO's culpability.