On October 15, 2020, the Securities and Exchange Commission (“Commission” or “SEC”) announced settled charges against Andeavor LLC for internal accounting controls violations relating to a stock buyback plan it implemented while it was in discussions to be acquired by Marathon Petroleum Corp. in 2018. Andeavor consented to entry of the settled order finding violations of the internal controls provisions of Section 13(b)(2)(B) of the Securities Exchange Act of 1934, agreeing to pay a $20 million penalty to settle the charges.
While the specific violation is a public company violation of internal accounting controls, the SEC action provides valuable insights on how to establish an effective process for obtaining an accurate and complete understanding of the facts and circumstances necessary to determine whether a person is in possession of material non-public information (“MNPI”), and therefore prohibited from engaging in securities transactions. It also provides insights on key factors to consider when determining if the probability of a business combination is sufficiently high as to become MNPI.
Andeavor’s CEO directed the company’s CFO to initiate a $250 million stock buyback which would only be permitted if, among other things, the company was not in possession of MNPI. The order found that Andeavor used an abbreviated and informal process to evaluate whether the requirements for the stock buyback were satisfied, including that the company was not in possession of MNPI. Based on our review of the order, the following are key parts of an effective process for obtaining an accurate and complete understanding of the facts and circumstances necessary to determine whether a person is in possession of MNPI:
In the case of Andeavor, the order found specifically that the process for evaluating the materiality of the acquisition negotiations did not include discussing, with the CEO, the likelihood of a deal between Andeavor and Marathon. This was a material oversight because Andeavor’s CEO was the primary negotiator with Marathon, and was the person in the best position to understand the likelihood of the acquisition occurring.
Based on our review of the order, the following are key factors that seemed to play into the Commission’s belief that the probability of the acquisition was sufficiently high as to have become MNPI:
Failure to thoroughly consider these factors and talk with the CEO resulted in the target failing to appreciate that the probability of Andeavor’s acquisition by Marathon was sufficiently high at that time as to be material to investors. The SEC made it clear that an acquisition need not be more-likely-than-not to occur for it to be material, particularly with regard to a small corporation.1
This case makes clear the importance of effective internal accounting controls when a company is contemplating transactions with its shareholders. More broadly, it makes clear the importance of having an effective process for evaluating whether a company or an insider has material non-public information learned about significant corporate developments. The SEC’s order is available here.
1 The order referenced, for example, Basic, Inc. v. Levinson, 485 U.S. 224, 238-39 (1988) (quoting SEC v. Geon Indus., Inc., 531 F.2d 39, 47-48 (2d Cir. 1976)) (“Since a merger in which it is bought out is the most important event that can occur in a small corporation’s life, to wit, its death, we think that inside information, as regards a merger of this sort, can become material at an earlier stage than would be the case as regards lesser transactions – and this even though the mortality rate of mergers in such formative stages is doubtless high.”).