Securities & Exchange Commission v. Sequential Brands Group, Inc.

Background

The Securities and Exchange Commission (SEC) sued Sequential Brands Group, Inc. (Sequential), alleging that the company engaged in negligence-based fraud and violated federal securities and accounting laws. The SEC alleged violations of Section 17(a)(3) of the Securities Act; Section 13(a) of the Exchange Act and related reporting rules; Section 13(b)(2)(A), concerning books and records; and Section 13(b)(2)(B), concerning internal accounting controls.

Sequential acquired consumer brands and therefore carried substantial goodwill on its balance sheet. Goodwill is an intangible asset reflecting, among other things, the value of a company’s brands and customer relationships. Under generally accepted accounting principles and Accounting Standards Codification 350, a company must test goodwill for impairment at least annually and also when events suggest that its value may have fallen below its recorded amount.

The SEC alleged that Sequential’s stock price had declined and that two quantitative analyses in late 2016 showed that the company’s fair value was below its carrying amount by approximately $63 million and $96 million. According to the complaint, Sequential did not give those analyses to its independent auditor. Instead, its accounting and finance personnel conducted a qualitative assessment that omitted several negative factors and concluded that goodwill was not impaired.

The SEC further alleged that Sequential’s public filings overstated goodwill, assets, earnings, and stockholders’ equity while understating losses and accumulated deficit. The complaint also alleged that Sequential changed its goodwill-assessment method in the third quarter of 2017 and ultimately recorded a $304.1 million goodwill impairment in the fourth quarter of 2017. The SEC alleged that Sequential had only one internal control concerning goodwill impairment testing and that its personnel did not follow the company’s stated process or maintain supporting documentation.

Sequential’s Motion

Sequential moved to dismiss the entire complaint under Federal Rule of Civil Procedure 12(b)(6), which tests whether a complaint states a legally sufficient claim. It argued that the SEC had not adequately pleaded an offer or sale of securities, deceptive conduct supporting scheme liability, false statements, material misstatements, accounting violations, or inadequate internal controls.

Court’s Analysis

The court held that the allegations concerning Sequential’s registration and issuance of restricted stock and stock units to employees, consultants, and directors under employment or consulting agreements were sufficient at this stage to raise an inference of an offer or sale of securities.

The court also concluded that the SEC plausibly alleged deceptive conduct supporting its claim under Section 17(a)(3). The alleged conduct included disregarding quantitative evidence of impairment, conducting a biased qualitative assessment, changing the goodwill-assessment method, and making repeated misleading statements in public filings. The court rejected Sequential’s argument that alleged misrepresentations or omissions could not support scheme liability, explaining that deceptive conduct may be based on misleading statements or omissions.

The court found that the SEC adequately alleged false or misleading statements. Sequential’s public descriptions of its goodwill-assessment method could have suggested that it would follow a particular sequence of testing and consider its market capitalization. The complaint alleged that Sequential did not follow that described approach after receiving quantitative evidence of impairment. The court also treated Sequential’s goodwill determination as a statement of opinion and held that the complaint plausibly alleged that the opinion did not fairly align with information Sequential possessed at the time.

The court further held that the alleged misstatements and omissions could be material, meaning important to a reasonable investor. The SEC alleged that the unrecorded impairment was around $100 million, would have equaled 7 percent of total assets, and would have made Sequential’s 2016 loss 54 times larger. The complaint also alleged effects on other financial measures.

As to the books-and-records claim, the court held that the SEC plausibly alleged that Sequential failed to account for goodwill as required by Accounting Standards Codification 350. The complaint alleged that Sequential’s quantitative assessments indicated impairment but that the company did not measure the impairment or reduce the recorded goodwill. The court also held that the alleged resulting overstatements and understatements supported an inference of accounting violations.

Finally, the court held that the SEC plausibly alleged a violation involving internal accounting controls. The allegation that Sequential had only one control for goodwill impairment testing, combined with the alleged lack of internal checks on the personnel making the relevant judgments, was sufficient to state a claim.

Disposition

Judge J. Paul Oetken denied Sequential’s motion to dismiss the complaint. The court directed the Clerk of Court to close the motion at Docket Number 11. The opinion decided only whether the SEC’s allegations were sufficient to proceed; it did not determine whether Sequential ultimately violated the cited laws.