Enforcement News: SEC Brings Charges In Connection With False and Misleading Statements about Related-Party Loans

• Posted on: Aug 17 2022

By: Jeffrey M. Haber

The disclosure of related-party transactions is an important part of a company’s corporate governance and financial statements. It provides transparency as to how the entity’s financial position and financial performance may be affected by transactions with related parties.¹ 

The definition of a related party is not limited. A related party may be someone who has direct or indirect control (including common control), joint control or significant influence over another.² A controlling investor and key management person, as well as their close family members, can be a related party.³

An entity’s related-party relationships and transactions can also take a variety of forms.⁴ These transactions may occur in the normal course of business, such as the purchase and sale of goods, cash pooling or central treasury functions, management services, and loans and guarantees.⁵ They may or may not be conducted on an arm’s-length basis.⁶

Although related-party transactions are themselves legal, they may create conflicts of interest or lead to other illegal situations.⁷ For this reason, securities regulators, like the Securities and Exchange Commission (“SEC”), require disclosure of related-party transactions so that investors and shareholders can assess whether such transactions are conflict-free and do not affect shareholder value or the corporation’s profits negatively.⁸ 

On August 16, 2022, the SEC announced (here) that it charged Eagle Bancorp, Inc., based in Bethesda, Maryland, and its former Chief Executive Officer and Chairman of the Board, Ronald D. Paul, with negligently making false and misleading statements about related-party loans extended by the bank to Paul’s family trusts. Eagle and Paul agreed to settle the SEC’s charges.

In its Order Instituting Cease-and-Desist Proceedings, the SEC found that, from March 2015 through April 2018, Eagle failed to disclose loans to Paul’s family trusts totaling at times nearly $90 million in the related-party loan balances included in its annual reports and proxy statements (here). The SEC also found that Eagle improperly omitted tens of millions of dollars of loans to Eagle directors and their family members from these related-party loan balances. Both SEC regulations and Generally Accepted Accounting Principles (“GAAP”) required Eagle to disclose these related-party transactions.

The SEC further found that, following a December 2017 short seller’s report asserting that Eagle had made significant undisclosed loans to Paul’s family trusts, Eagle and Paul falsely stated in press releases, news articles, and meetings with investors that the trust loans were not related-party loans and that Eagle was in compliance with all related-party loan requirements. The SEC said that even though Eagle’s independent auditor and primary regulator concluded that the trusts were related parties under GAAP and banking regulations, respectively, Eagle failed to disclose the trust loans as related-party loans in its 2017 annual report.

The SEC claimed that Eagle violated the negligence-based anti-fraud, proxy, reporting, books and records, and internal accounting controls provisions of the federal securities laws. Without admitting or denying the SEC’s findings, Eagle agreed to cease and desist from future violations and to pay disgorgement of $2.6 million, prejudgment interest of $750,493, and a civil penalty of $10 million.

In a complaint filed in the United States District Court for the Southern District of New York against Paul (here), the SEC charged Paul with violating the negligence-based antifraud and proxy provisions of the federal securities laws and making false certifications. Without admitting or denying the SEC’s allegations, Paul agreed to a permanent injunction, a two-year officer and director bar, and disgorgement of $109,000, prejudgment interest of $22,216, and a penalty of $300,000. The settlement is subject to court approval.

“Adequate disclosures of related party transactions are essential to enable investors to evaluate an issuer’s corporate governance,” said Sanjay Wadhwa, Deputy Director of the SEC’s Enforcement Division. “Here, faced with a short seller’s report alleging undisclosed related party loans by the bank, both Eagle and Paul failed to respond truthfully and accurately.”

In a parallel action, the Federal Reserve Board announced settled enforcement actions against EagleBank and Paul.

Jeffrey M. Haber is a partner and co-founder of Freiberger Haber LLP.

This article is for informational purposes and is not intended to be and should not be taken as legal advice.

Footnotes

1. KPMG Advisory, Related Party Disclosures: IFRS® Standards vs US GAAP (June 4, 2021) (here).
2. Id.
3. Id.
4. Id.
5. Id.
6. Id.
7. Will Kenton, Related-Party Transaction, Investopedia (April 2022).
8. Id.