SEC – GM Settle Internal Controls Action

Effective internal controls are critical to any organization. The Commission has focused on these controls, brining enforcement actions in recent months tied to internal control issues. Its latest case in this area names General Motors Company as a Respondent. In the Matter of General Motors Company, Adm. Proc. File No. 3-17797 (January 18, 2017).

The case centers on the failure of GM’s internal controls to alert the firm to a potential loss contingency regarding a February 2014 recall of over 600,000 vehicles to repair a defective ignition switch.

GM had a multi-step process for assessing the prospect of a recall. First, for small recall situations – those up to $5 million — the firm used an actuarial based estimation approach for a per-vehicle accrual at the time of each sale. For larger recalls the firm recorded a specific accrual for each recall at the time it became probably and estimable.

In 2012 GM had a formal recall process. It included an investigation and, when appropriate, a recall decision made through a process that involved three different committees. As the issue moved through the committee process it would be placed on the Emerging Issues List. At that point the company typically considered a recall to be probable and estimable within the meaning of ASC 450 which governs loss contingencies.

ASC 450 requires the issuer to accrue the estimated loss. Initially, if a loss is probable but cannot be estimated, disclosure is required along with a reasonable estimate or range for the loss. On the other hand, if a loss contingency is reasonably possible and estimable, there must be consideration of whether disclosure is necessary. At GM if the engineers at the first step in the possible recall process determined that there was a problem but that the evidence did not establish that there may be a defect requiring a potential recall the issue would not reach the stage where it would be placed on the Emerging Issues List.

By 2012 GM engineering was reviewing airbag non-deployment claims in certain vehicles. It appeared that the issue was tied to a defective switch which could result in safety issues. Nobody advised the Warranty Group between 2012 and late 2013 about the question. That group thus could not make an ASC 450 reasonableness decision on the issue in advance of it being placed on the Emerging Issues List.

In November 2013 the Warranty Group received information about a potential recall. The next month the defective switch issue was placed on the Emerging Issues List. The Warranty Group accrued about $41 million for estimated costs from recalling three models with the defective switch. In February 2014 GM notified the National Highway Traffic Safety Administration that it was recalling over 600,000 vehicles to repair a defective ignition switch.

Later in 2014 GM revamped its processes for investigating and deciding on potential recalls. Warrant Group, as part of the changes, is required to be notified earlier in the process and separate from the Emerging Issues List so a timely reasonably possible determination followed by, if necessary, appropriate disclosure can be made. The Order alleges violations of Exchange Act Section 13(b)(2)(B), prior to the 2014 revision to the firm’s policies.

General Motors resolved the issue, consenting to the entry of a cease and desist order based on the Section cited in the Order. The firm will pay a penalty of $1 million.

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SEC – BlackRock Settle Whistleblower Claim

The protection of whistleblowers has been a recurrent theme in recent SEC enforcement actions. The agency has brought a series of actions designed to protect the right of employees to report wrong doing to the Commission unimpeded by their employer. Asset manager BlackRock is the latest firm to settle with the SEC on this issue. In the Matter of BlackRock, Inc., Adm. Proc. File No. 3-17786 (January 17, 2017).

BlackRock, whose shares are listed on the NYSE, has historically entered into voluntary separation agreements with many of its departing employees. After the Commission adopted Exchange Act Rule 21F-17 the firm revised its form of separation agreement. The revision provided that the departing employee agreed to waive its recovery of incentive fees for reporting misconduct under Dodd-Frank in exchange for monetary separation payments and other consideration from BlackRock.

The new provision did not prohibit departing employees from reporting to the Commission or any other government agency regarding possible violations of law. Rather it provided that “To the fullest extent permitted by applicable law . . . you waive any right to recovery of, incentives for reporting of misconduct, including without limitation, under the Dodd-Frank . . . [and SOX] relating to conduct occurring prior to the date of this Agreement.”

Prior to being contacted by the staff in this matter BlackRock voluntarily revised its separation agreement. This was undertaken as part of a periodic review and update of its agreements, conducted in March 2016. The revision dropped the waiver language. By that date, however, 1,067 separation agreements had been executed that contained the waiver language.

BlackRock undertook remedial actions in resolving this matter. Those included yearly mandatory training that provides a summary of, and link to, a document entitled “Global Policy for Reporting Illegal or Unethical Conduct.” That document summarizes several of the rights employees have under the Commission’s Whistleblower Program. The firm also agreed to an undertaking pursuant to which it will make reasonable efforts to contact each former employee who executed a separation agreement that contained the waiver provision and provide them with a link to the document cited above. In addition, the firm will provide a statement that noting that BlackRock does not prohibit former employees from seeking and obtaining a whistleblower award from the SEC under Exchange Act Section 21F.

The Order alleges violations of Exchange Act Rule 21F-17. That Rule, designed to encourage persons to report to the SEC, provides in part that “No person may take any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation . . .”

To resolve this action BlackRock consented to the entry of a cease and desist order based on the Rule cited in the Order. The firm will also pay a penalty of $340,000.

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