The standards by which issuers or market professionals are governed are critical. Those standards guide the dealings of investment advisers, for example, entrusted by clients with their capital. It is for this reason that many of the Commission’s enforcement actions center on a breach or violation of the governing standards of the organization. Examples of those cases run the gamete from insider trading which is based on a breach of standards to those involving investment advisers who fail to properly disclose fees.
The Commission’s most recent action against a CFO dealing with questions regarding related party transactions or RPTs is based on this approach. There the CFO essentially did an end run around the firm’s well-established principles governing RPTs. In the Matter of Mark E. Kchenrither, Adm. Proc. File No. 3-19009 (March 1, 2019).
Mark Kuchenrither served as Executive Vice President and CFO of EZCORP, a firm with two classes of shares. The Class A shares are listed on NASDAQ but do not carry voting rights. The Class B shares do have voting rights. All of those shares are owned by the Controlling Shareholder.
The board of directors approved a Policy for Review and Evaluation of Related Party Transactions in September 2009. The firm’s General Counsel developed a process to implement the RPT Policy under the supervision of the audit committee which had been delegated authority to assess the fairness of related party transactions. The process was designed to ensure that transactions involving the company and the Controlling Shareholder were fair.
The Audit Committee retained an Advisor to furnish an opinion each year on whether the annual consulting agreement with the Controlling Shareholder was financially fair to EZCORP. That process in part hinged on a comparison of the proposed fee involved in the arrangement with the Controlling Shareholder with EZCORP’s projected revenue, earnings and other metrics for the coming year.
Over a four year period, beginning in 2009, the Advisor provided an opinion that the proposed consulting agreement was fair. The company then disclosed the agreement in a Form 8-K as a related party transaction.
In 2014 the Advisor informed the company that it would not approve the proposed Consulting Agreement because the consulting fee exceeded the acceptable fee-to-earnings ratio based on EZCORP’s financial projections. The Controlling Shareholder rejected a request to reconsider the fee.
The Audit Committee Chairman then asked Mr. Kuchenrither to reassess the financial position of the company since the Advisor’s determination hinged on the fact that the firm’s projected earnings were less than $240 million. The CFO revised the earnings projection over the next four days, increasing it from $187 million to $242.9 million. The increase was based on two assumptions: 1) that EZCOERP would complete a $300 million high-yield debt offering and 2) that the firm would use part of the proceeds to acquire several companies during the year. After reviewing the revisions, the Advisor approving the Consulting Agreement.
The CFO did not, however, have a reasonable basis for the two assumptions on which the new projections were based. The CFO essentially double counted the impact of the high-yield debt offering since it was included in the original financial projections. Reliance on the contemplated acquisitions was equally flawed. Indeed, the firm had conducted few discussions with its list of proposed targets. That fact was known, or should have known, to the CFO since he was a member of the acquisition committee. Nevertheless, EZCORP proceeded to disclose the new agreement filings with the Commission. The filing did not include any discussion regarding the Advisor’s initial opinion or the CFO’s revamping of the financial projections based on flawed assumptions. The Order alleges violations of Securities Act Sections 17(a)(3).
To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order. He also agreed to pay a penalty of $50,000.
Program: Women in Compliance, March 19, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.