sec-filingsThe Securities and Exchange Commission (SEC) recently brought a civil enforcement action against a former CFO of a publicly traded corporation for failing to disclose perquisite (perk”) compensation paid to corporation’s CEO.

The CEO enjoyed a life of luxury as the founder and executive of a mailing list company including private jet travel and his 80–foot yacht.  His company reimbursed him or one of his separate business entities for a variety of expenditures. This arrangement allowed the CEO to gain additional income without paying additional income taxes. As a result of these transactions and reimbursements, the SEC brought an action against the company’s former CFO for violating the Securities Exchange Act of 1934 (the “Exchange Act”).

In 2010, the SEC brought this civil enforcement action against the ex-CFO for numerous violations of the Exchange Act. The SEC presented evidence at trial to support its claim that the publicly traded company failed to report related-party transactions and the benefits that the CEO received. The SEC called numerous witnesses, including the ex-CFO. The SEC also presented an expert witness, Dr. STH, a partner of a financial advisory firm, licensed CPA, and former professor. STH testified that after an independent review of the company’s filings, he believed the filings did not adequately disclose perks or related-party transactions. The SEC introduced private jet flight logs, credit card statements, the defendant’s calendar, and invoices from separate business entities wholly owned by the CEO. The company reimbursed the CEO’s private jet travel, yacht payments and expenses, portions of his wedding in South Africa, luxury cars, his California home, membership dues for 30 private country clubs, and personal life insurance policies. According to the SEC’s expert, the company reported zero perk compensation related to all of these personal benefits.  The SEC also presented evidence that the former CFO was aware of these payments and that they should have been reported in the company’s filings, which were certified by the defendant.

At the close of the SEC’s case against the former CFO, he moved for judgment as a matter of law, but the district court denied the motion.  The defendant presented no witnesses or other evidence. The jury returned a verdict in favor of the SEC on every claim. The district court permanently enjoined the defendant from committing further securities violations, enjoined him from acting as an officer or director of a publicly traded company for three years, imposed a $50,000 civil penalty, and noted that he had “acted in bad faith toward” the company’s shareholders. Finally, the court barred the defendant “from seeking payment, reimbursement, or indemnification from any third party, including [his former employer], for the civil penalties ordered herein.”

The defendant raised several arguments on appeal, among them that the district court erred by admitting the testimony of the SEC’s expert witness.  The defense raised two claims with respect to Dr. STH’s expert testimony that, according to the defendant, demonstrated the district court abused its discretion by allowing him to testify. First, STH failed to consider whether his findings of error were within the zone of reasonableness when viewed in light of the company’s actual filings.  Second, STH relied upon a different standard than the standard than that of the SEC for determining whether an expense was a perk or a business expense.

STH testified that the company under-reported perk compensation in the amount of $2.1 million in 2003 and $1.3 million in 2006. The expert stated that from 2003 through 2006 the company disclosed no perk related to private jets travel, the yacht, credit card expenses, club memberships, vehicles, private residences, and life insurance policies. Nonetheless, STH found that the CEO’s perk benefits were underreported and testified that most of the expenses the CEO charged the company were proper business expenses.

The ex-CFO argued that the expert’s testimony was not helpful to the jury because he failed to calculate whether an error rate existed between what STH concluded should have been reported and what the company originally reported.

Judge Bobby E. Shepherd of the United States Court of Appeals for the Eighth Circuit wrote that aside from calculating an error rate, it wasn’t clear what facts the defendant argued that the expert failed to consider that rendered his expert opinion invalid. STH testified regarding his analysis of federal securities-reporting requirements and company’s documentation. Judge Shepherd said that the expert’s conclusions benefitted the jury in that they assisted in understanding how a professional financial officer or auditor would analyze whether a benefit was personal or business, as well as STH’s application of that analysis to the facts of this case. STH’s testimony, even without calculating an error rate, the judge held, assisted the jury in understanding whether a benefit should be considered a perk, and analyzed the voluminous documentation that spanned a period of several years.

The defendant also asserted that STH erroneously relied upon an incorrect standard for determining whether an expense was a perk, and that he used the IRS’s “primary-purpose” test rather than the SEC’s “integrally-and-directly-related” test. The SEC’s guidance on the “integrally-and-directly-related” test notes that it is intentionally broader than tax laws. The district court found that the SEC standard—“integrally and directly related”—results in a company disclosing more items than the IRS standard—“primary purpose”—and overruled The defendant’s objections to STH’s testimony. Although the district court allowed the expert to testify, it limited the scope of his testimony as it related to the defendant’s legal duties, the misleading nature of any disclosures, and the former CFO’s intentions.

The defendant relied on United States v. Wintermute (8th Cir. 2006) in which the Eighth Circuit affirmed the district court’s decision to exclude an expert’s testimony because it misconstrued “the legal question at issue.” In that case, the expert’s testimony erroneously heightened the government’s burden of proof.  Judge Shepherd explained that while an expert cannot misconstrue a legal issue, case law has distinguished instances where parties disagree over the appropriate methodology.

The expert’s reliance on the primary-purpose test was not a basis for excluding his testimony, Judge Shepherd wrote. The defendant misconstrued STH’s approach by indicating that he relied solely on the “primary purpose” standard.  However, the expert testified repeatedly that the primary-purpose test was used to determine whether a benefit was integrally and directly related to the CEO’s position at the company. Despite the ex-CFO’s contention that this standard didn’t fit within this case, “mere disagreement with the assumptions and methodology used does not warrant exclusion of expert testimony.” Even though the defendant repeatedly argued that the primary-purpose test could in theory result in a business expense being misclassified as a perquisite, he didn’t assert that happened here.

The Eighth Circuit held that STH’s use of the primary-purpose test as a means for applying the integrally-and-directly-related standard did not misconstrue a legal issue or alter the legal standard that was required to apply as CFO. As a result, the district court did not abuse its discretion by admitting the expert’s testimony.

By:  Kurt Mattson, J.D., LLM

S.E.C. v. Das, 723 F.3d 943, Fed. Sec. L. Rep. P 97,578  (C.A.8 (Neb.) July 29, 2013).