United States: SEC Charges Compass Minerals With Disclosure Violations Resulting From "deficient Disclosure Process"

Toward the end of last month, the SEC announced settled charges against Compass Minerals International, Inc., for alleged disclosure violations that were "the consequence of a deficient disclosure process." In the Order, the SEC alleged that Compass misrepresented the impact of a technology upgrade at its Goderich mine—the world's largest underground salt mine—which the company had claimed would lead to cost savings, but actually led to increased costs and below-expectation results. Central to the case, however, was the purported failure of the company's disclosure controls that resulted in the misleading statements: "statements to investors were not reviewed by personnel who were sufficiently knowledgeable about both Compass's operations and its disclosure obligations." The company was also charged with failing to disclose the potential financial risks arising out of the company's contamination of a river in Brazil with excessive discharges of mercury, a failure the SEC also attributed to inadequate disclosure controls. According to Melissa Hodgman, Associate Director of the Division of Enforcement, "[w]hat companies say to investors must be consistent with what they know. Yet Compass repeatedly made public statements that did not jibe with the facts on—or under—the ground at Goderich....By misleading investors about mining costs in Canada and failing to analyze the potential financial consequences of its environmental contamination in Brazil, Compass fell far short of what the federal securities laws require." Compass agreed to pay $12 million to settle the charges.

Misrepresentations regarding mining system upgrade. As described in the Order, Compass considers its Goderich salt mine in Canada to be its "crown jewel"—the "biggest underground salt mine in the world and the largest single contributor to Compass's financial results, accounting for about one-third of the company's earnings." In late 2014, the company's board approved a multi-year project to upgrade its mining system at Goderich from a traditional drilling-and-blasting system to a system of continuous mining and continuous haulage ("CMCH") that "uses complex machines to cut salt and transport it for processing on flexible conveyor trains." The purpose of the plan was to reduce the cost per ton (unit) of salt, which cost typically decreases as production volume increases, making production volume a "key variable." The company forecast that the cost of the project would be around $70 million to $80 million. Based on an assumed production volume of 7.5 million tons of salt per year, however, after implementation, the new CMCH system was forecast to reduce the unit cost at Goderich by over 23%, saving the company about $27 million annually beginning in 2018. In April 2015, on an earnings call, the CEO estimated the savings from the shift to CMCH to be about $30 million annually beginning in 2018.

However, the Order alleges, the challenges of technology and geology together conspired to cause the project to fall well short of production expectations. In 2016, only 1.4 million tons of salt were produced, leading to unplanned expenses, such as the purchase of salt from third parties to meet commitments, which resulted in "significant increases in unit cost." This failure to meet expectations was reflected in a presentation sent to the CEO and led to a management change at the mine in 2017. At the same time, the company revisited its projections, concluding that many of its assumptions were unreliable. According to the SEC, the new projections "showed that even if the CMCH equipment could produce 7.5 million tons annually, it would not directly save the company about $30 million" as had been indicated to investors—the number was really closer to $18 million in projected savings at that production level. What's more, the company was not close to meeting the volume production assumption, and ramping up additional CMCH equipment that the company installed was taking longer than expected. As a result, unit costs were continuing to increase.

What was the company's response? According to the Order, the response by Compass executives was to come up with a new model that would support the $30 million savings forecast. The new model included some other current initiatives unrelated to CMCH and "some future initiatives that had not yet been identified. Compass finance and operations employees, together with the company's then-CEO, then-CFO, and then-General Counsel, reviewed the new forecast and determined that Compass would continue to tell investors it expected CMCH to generate $30 million in cost savings." In a 2017 earnings call, the CEO said that "our major investments at Goderich are progressing on plan," and the CFO confirmed the $30 million cost savings estimate for 2018. Citing the 2015 Omnicare decision (regarding statements of opinion), the SEC characterized these statements as "misleadingly incomplete because they did not fairly align with the information Compass had at the time. Compass knew of undisclosed material facts that substantially undermined those assertions." According to the SEC:

According to the Order, through the remainder of 2017, in statements that had been vetted by "numerous executives," the CEO and CFO continued to confirm to investors the $30 million savings estimate from the CMCH project, without disclosing the production issues, even though other executives provided reports to the CEO, CFO and Board "showing Goderich continuing to fall far short of the production expectations underlying these cost savings models." When, in mid-2018, the company did discuss an increase in costs on an earnings call, the CFO falsely attributed the increase, the SEC alleged, to a "ceiling fall" incident that interrupted operations, not the CMCH upgrade.

The SEC also alleged that, in its 10-K, the company materially misrepresented the Goderich mine's production capacity as well as, at an investor conference, its current production levels. According to the SEC, the Goderich mine produced less than four million tons of salt in 2018 (compared to the assumed production volume of 7.5 million), at "a unit cost that was more than double what they were before Compass began the CMCH project four years earlier." The shortfall in production increased at the Goderich mine from 800,000 tons in 2016 to 1.5 million tons in 2017, to 2.4 million tons in 2018, which increased costs and reduced income. The SEC charged that the company failed to disclose the decline in salt production as a known trend, disclosure of which was "necessary to make other required statements in Compass's filings, including the statements about Goderich's annual production capacity, not materially misleading."

When, in October 2018, Compass pre-announced its Q3 2018 results, which were "significantly below expectations," and lowered its outlook, the "company attributed the miss to production shortfalls at Goderich due to the slower than expected ramp-up of the CMCH system following a labor strike. Compass's stock price fell more than 32% over the next two days, as financial analysts and investors expressed frustration with the company's failure to communicate production issues or deliver the expected benefits at Goderich." For example, "a large shareholder told Compass, 'take a serious look at your original 2018 targets, and how you communicated and clung and "aspire" since that day, and then look at the stock performance since that day and seriously ask yourself, is this any way to run a public company?'"

Environmental issues in Brazil. The problem with the CMCH project was not the only problem Compass faced. In 2017, as a result of an ethics hotline tip, the company learned that its Brazilian chemical plant had been discharging mercury into a river above permitted levels and covering up the problem by providing environmental authorities with inaccurate reports that cherry-picked mercury testing results. Compass terminated the plant manager, began to submit accurate environmental reports and started to remediate the mercury contamination and improve lab testing practices.

However, the SEC alleged, regulators could have closed down the facility and Compass could have been subject to claims for civil liability; however, Compass "did not adequately assess the probability of these risks coming to fruition nor did the company attempt to quantify their financial impacts if they were to occur." The SEC charged that the company "did not have adequate controls and procedures in place to ensure that all potentially material risks and uncertainties were adequately analyzed by the employees at the company responsible for advising Compass's management of the company's disclosures obligations so that Compass's principal executive and financial officers could make appropriate determinations about disclosures."

Accounting issue. In addition, the Order states that the company used a salt inventory accounting methodology that did not comply with GAAP, which had a material impact on interim, but not annual, results. As a result, the company disclosed a material weakness in its internal control over financial reporting and restated its quarterly segment results for several quarters.

Violations. The SEC charged that Compass violated Securities Act Sections 17(a)(2) and (3) in connection with the offer and sale of securities, Exchange Act Section 13(a) and Rules 13a-1, 13a-13 and 12b-20 in connection with misleading periodic reports, Exchange Act Sections 13(b)(2)(A) and (B) in connection with books and records and internal accounting controls, and Exchange Act Rule 13a-15 in connection with disclosure controls and internal controls.

The SEC took into account a number of remedial acts by Compass, including creating a new position of Chief Accounting Officer, developing new disclosure controls, creating a new disclosure committee and adding new directors with industry experience in finance and accounting, as well as safety and sustainability.

Compass was required to pay a civil money penalty of $12 million and to engage an independent compliance consultant to review the company's practices and submit a report with recommendations, which the company undertook to follow.

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