By Cameron W. Ellis
Last month, the SEC issued its annual report. A few days ago, the SEC announced an accounting fraud enforcement action that reinforces several important areas—both areas of focus and challenges—in the report.
The Securities and Exchange Commission’s Division of Enforcement’s 2019 fiscal year report (“Report”)
On November 6, 2019, the SEC issued the Report. The Report primarily identifies the SEC’s initiatives and continuing areas of focus for 2019 and analyzes the results of its cases—breaking those results down by types of cases, recoveries, individual actions, non-monetary relief, litigation and trial updates, and recurring challenges.
As the SEC’s “Continuing Areas of Focus,” the Report identifies coordination with law enforcement, accelerating the pace of investigations, publicly messaging the credit received for meaningful cooperation, and accelerating evaluation of whistleblower awards. These continuing areas can overlap. For example, meaningful cooperation and coordination with law enforcement can speed along investigations.
Among the SEC’s challenges, the Report identifies one of the primary reasons for accelerating investigations: the ongoing impact of Kokesh. Kokesh is the Supreme Court’s June 2017 decision in Kokesh v. SEC, 137 S.Ct. 1635 (2017). The Supreme Court stated that “SEC disgorgement constitutes a penalty within the meaning of § 2462,” a section imposing a five-year statute of limitations. Before Kokesh, the SEC often sought and secured disgorgement of ill-gotten gains resulting from securities violations older than five years. As the Report states, “many securities frauds are complex, well concealed, and are not discovered until investors have been victimized over many years.” After Kokesh, the SEC has had to forgo “approximately $1.1 billion dollars in disgorgement in filed cases,” shift its resources away from older securities frauds, and increase its efforts “to uncover, investigate, and bring cases as quickly as possible.” Regarding that speed, “just under 24 months elapsed between case opening and filing of an enforcement action” but “in financial fraud and issuer disclosure cases,” an average of 37 months elapsed from opening to filing.
In addition to the areas of continuing focus and the challenges of Kokesh, the Report highlights enforcement against individuals “[a]s the Commission’s most effective method of achieving deterrence,” especially individuals “at the top of the corporate hierarchy—such as chief executive officers, chief financial officers, and chief operating officers—as well as gatekeepers such as accountants, auditors, and attorneys.” About 57% of standalone actions involved charges against one or more individuals.
The MiMedx Enforcement Action
On November 26, 2019, the SEC filed a complaint that provides a timely example of the areas of focus, challenges, and priorities in the Report.
In SEC v. MiMedx Group, Inc. (“MiMedx”), Parker H. Petit, William C. Taylor, and Michael J. Senken, the SEC charges a Georgia-based biotech company and its former CEO, COO and CFO with defrauding investors by misstating the company’s revenue. In particular, the SEC alleges that from 2013 to 2017, MiMedx prematurely recognized revenue from sales to distributors and exaggerated the company’s revenue growth even though the CEO and the COO had undisclosed side arrangements with five distributors allowing those distributors to return product to MiMedx or to avoid paying MiMedx until the distributors made sales. The 84-page federal court complaint (“Complaint”) filed in the Southern District of New York charges all defendants with violating the antifraud, reporting, books and records, and internal control provisions of the federal securities laws. The Complaint also seeks injunctive relief, officer-and-director bars against the individuals, disgorgement plus interest, penalties, and clawback of bonuses, incentive, and equity-based compensation paid to the CFO and CEO.
Along with the filing, the SEC announced that MiMedx cooperated with the investigation, received appropriate credit for that cooperation, and, without admitting or denying the allegations, agreed to settle and pay a $1.5 million penalty. The Press Release also noted the cooperation of the U.S. Attorney’s Office for the Southern District of New York.
Interestingly, given the Complaint’s references to both internal and external people raising concerns about MiMedx’s accounting, the MiMedx action seems likely to be based at least in part on one of the “thousands of whistleblower tips” that the SEC receives. In addition, the Complaint details the steps taken to investigate MiMedx’s revenue recognition practices by outside counsel, outside consulting and outside auditors.
The investigation apparently started around September 2017 when the SEC issued a subpoena to MiMedx.
Notwithstanding the challenges of Kokesh, the SEC continues to focus its Enforcement resources on long-running financial fraud cases and to bring those cases in federal court. Kokesh subjects SEC disgorgement to a five-year statute of limitations from the time the claim accrues. Assuming no tolling or other theory exists to delay accrual of a claim, the July 2013 stock offering is beyond the five-year window. That stock offering represents the largest identified profit from the allegedly fraudulent practices in the Complaint. Further, in a few months, Liu could invalidate SEC disgorgement in federal court cases. Despite the risk of having a limited disgorgement remedy, the SEC has chosen to pursue the MiMedx action in federal court.
Individuals are the focus of this SEC enforcement action. The SEC views individual accountability as the key to deterrence. In the MiMedx action, the SEC, once again, affirms this view. The corporation—subject to court approval—is out of the case. The remaining defendants are MiMedx’s former top-level financial personnel—the CEO, the CFO, and the COO. Indeed, beyond the underlying side agreements, the Complaint details—and asserts liability arising out of—actions taken by these executives after questions about MiMedx’s accounting arose. Moreover, the Complaint seeks an order that the CEO and the CFO “reimburse MiMedx for all bonuses, incentive-based and equity-based compensation.” Beyond the c-suite, given the many references in the Complaint to “MiMedx sales personnel,” the SEC may have considered charges against certain of the sales personnel too. In short, executives should consider engaging separate individual counsel early in the process—perhaps as early as an internal investigation—to protect their personal interests.
SEC continues to stress the importance of cooperation. On the day of filing, the SEC announced that it had settled with MiMedx for a $1.5 million penalty. Though the specifics of that cooperation are limited, perhaps because of the ongoing criminal probe, the Press Release confirms that MiMedx received appropriate credit for its cooperation. Indeed, the Complaint contains allegations that MiMedx profited from its fraudulent practices by, in part, selling stock, including sales through the exercise of stock options and raising $34 million in a public offering around July 3, 2013. The $1.5 million figure may indicate significant cooperation credit, significant issues with Kokesh and the dated public offering, or some combination of both.
The MiMedx action shows that the SEC is accelerating the pace of investigating financial fraud and suggests that the SEC will use coordination with law enforcement, cooperation, and whistleblowers to shorten the time frame. The Report stated an average of 37 months in financial fraud cases from case opening to filing. The MiMedx action appears to have been opened around September 2017, when MiMedx disclosed that it had received a subpoena. A filing in November 2019 suggests that the investigation lasted around 26 months, nearly a year below the average. It seems likely that MiMedx’s cooperation, the coordination with criminal prosecutors, and perhaps even information from one or more whistleblowers contributed to that faster pace. Individuals who have information about potential SEC violations should strongly consider engaging experienced whistleblower counsel.
Gatekeepers must continue to be wary. The SEC has repeatedly proclaimed its focus on gatekeepers, such as public company auditors and lawyers, in virtually every financial reporting investigation. The MiMedx action involved both outside lawyers and auditor gatekeepers. The Complaint seems to suggest that auditors and outside lawyers faced little, if any, direct enforcement risk, but, nevertheless, auditors and lawyers seem to be key sources of evidence for many of the allegations. Thus, auditors and lawyers nevertheless were likely heavily involved in the SEC investigatory processes—to say nothing of the ongoing criminal probe—including extensive document subpoenas and testimony.
Mr. Ellis is a former associate of Krevolin & Horst. The firm is actively representing clients adverse to MiMedx. Read more about our Whistleblower and White Collar practices here and here.
 Report at 7-8, available at https://www.sec.gov/files/enforcement-annual-report-2019.pdf.
 Report at ii.
 Kokesh, 137 S.Ct. at 1643.
 Report at 21.
 The impact of Kokesh may just be beginning. In part because of a footnote in Kokesh in which the Supreme Court raised the issue of statutory authority for SEC disgorgement in federal court cases, the Supreme Court recently granted cert in Liu v. SEC, a case in which the question presented is “Whether the Securities and Exchange Commission may seek and obtain disgorgement from a court as ‘equitable relief’ for a securities law violation[.]” Petitioner’s Petition for a Writ of Certiorari, Docket No. 18-1501, in the Supreme Court of the United States; see also Kokesh, 137 S.Ct. at 1642 n.3, Liu is set for argument on March 3, 2020.
 Report at 21.
 Report at 7.
 Report at 17.
 See Press Release 2019-243, SEC Charges Biotech Company and Executives With Accounting Fraud (Nov. 26, 2019), available at https://www.sec.gov/news/press-release/2019-243 (“Press Release”).
 See Press Release.
 See Complaint, ¶¶ 220-227.
 See Complaint, ¶¶ 256-261.
 Report at 8.
 See Complaint, ¶¶ 8-9, 26.
 See Complaint, ¶¶ 246-250.
 See, e.g., Complaint, ¶¶ 256-61.
 See, e.g., Press Release, MiMedx provides Information on Its Interaction With The SEC (Sept. 21, 2017), available at https://www.prnewswire.com/news-releases/mimedx-provides-information-on-its-interaction-with-the-sec-300523565.html.
 Complaint, ¶¶ 262-265.
 Complaint at p. 83.
 See, e.g., Complaint, ¶¶ 76-77.
 Complaint, ¶¶ 262-63.