United States: SEC Settles Charges With McDonald's And Former CEO Over Deficient Disclosures; Two Commissioners Dissent

Inappropriate relationships with employees have landed a number of CEOs and other executives in hot water in the last few years, especially as the MeToo movement gained momentum. But these aren't necessarily just employment issues, nor are they always limited to problems for the perpetrator. The SEC has just announced settled charges against McDonald's and its former CEO, Stephen Easterbrook, arising out of the termination of Easterbrook "for exercising poor judgment and engaging in an inappropriate personal relationship with a McDonald's employee in violation of company policy." The SEC alleged that Easterbrook made "false and misleading statements to investors about the circumstances leading to his termination in November 2019." But how was McDonald's alleged to have violated the securities laws? The SEC charged that McDonald's disclosures related to Easterbrook's separation agreement were deficient in failing to disclose that the company "exercised discretion in terminating Easterbrook 'without cause,'" allowing Easterbrook to "retain substantial equity compensation." The SEC's Director of Enforcement asserted that, "[w]hen corporate officers corrupt internal processes to manage their personal reputations or line their own pockets, they breach their fundamental duties to shareholders, who are entitled to transparency and fair dealing from executives....By allegedly concealing the extent of his misconduct during the company's internal investigation, Easterbrook broke that trust with—and ultimately misled—shareholders." According to the Associate Director of Enforcement, "[p]ublic issuers, like McDonalds's, are required to disclose and explain all material elements of their CEO's compensation, including factors regarding any separation agreements....Today's order finds that McDonald's failed to disclose that the company exercised discretion in treating Easterbrook's termination as without cause in conjunction with the execution of a separation agreement valued at more than $40 million." As reported by the WSJ, "[i]n a statement Monday, McDonald's said, 'The SEC's order reinforces what we have previously said: McDonald's held Steve Easterbrook accountable for his misconduct. We fired him, and then sued him upon learning that he lied about his behavior.'" Commissioners Hester Peirce and Mark Uyeda dissented from the Order, contending that the SEC's interpretation of the disclosure rule was beyond the rule's scope.

According to the Order, in October 2019, allegations were reported to the company that Easterbrook had engaged in an inappropriate personal relationship with an employee. The company's outside counsel conducted an internal investigation. In an interview that was part of the investigation, Easterbrook denied engaging in any sexual relationship with any other McDonald's employees and, the SEC alleges, also withheld other relevant information. The SEC also charged that Easterbrook knew, or was reckless in not knowing, that his misleading statements would "influence" the company's public disclosures.

In November 2019, McDonald's terminated Easterbrook for exercising poor judgment and violating the company's Standards of Business Conduct. The press release announcing his termination said that he "separated from the Company following the Board's determination that he violated company policy and demonstrated poor judgment involving a recent consensual relationship with an employee." Neither the company's letter to employees nor its press release regarding his termination, both of which Easterbrook had the opportunity to review in advance, disclosed information about his relationships with other McDonald's employees, which were not known to the company until July 2020.

Various compensation agreements with Easterbrook included in the definition of a termination "for cause" a termination due to violation of these Standards of Business Conduct; a termination "for cause" would result in the forfeiture of certain equity grants. However, in Easterbrook's separation agreement with McDonald's, his termination was characterized as "without cause," which allowed his equity "to continue to vest or become exercisable as originally scheduled" (approximate value $44 million). According to the Order, McDonald's has stated that, "had Easterbrook been candid with the company during the internal investigation, it would not have terminated him 'without cause.'"

An 8-K filed by McDonald's disclosing the termination of Easterbrook did not disclose his other improper relationships. In addition, according to the Order, in its say-on-pay proposal in its proxy statement, which included, by extension, the compensation to be paid under the separation agreement to Easterbrook, McDonald's described the termination as "without cause" and described the continued vesting of his equity pursuant to those agreements. However, the SEC asserted, the proxy statement "did not disclose that, absent the company's exercise of discretion in treating Easterbrook's termination as without cause, Easterbrook would have forfeited unvested options and PRSUs as a result of his termination on account of a violation of the Standards of Business Conduct."

In July 2020, after receipt of an anonymous tip, McDonald's conducted a second internal investigation, which uncovered information that Easterbrook had engaged in inappropriate personal relationships with other McDonald's employees. McDonald's then sued Easterbrook in Delaware Chancery Court seeking recovery of the compensation Easterbrook was paid under his separation agreement, claiming both breach of fiduciary duty and "fraud in the inducement related to Easterbrook's conduct during the course of the October 2019 internal investigation." In December 2021, McDonald's announced that it had reached a settlement with Easterbrook, in which Easterbrook would return his cash severance, prorated bonus and certain proceeds from the sale of securities as well as forfeit all outstanding equity and awards. The clawback was reportedly valued at more than $105 million.

The SEC charged that Easterbrook violated the antifraud provisions of Exchange Act Section 10(b) and Rule 10b-5 and Securities Act Sections 17(a)(1), (2)and (3), and caused the company to violate Section 13(a) and 14(a). The SEC imposed a five-year officer and director bar and a $400,000 civil penalty (as well as disgorgement of funds, which the company had already recouped).

The Order charged McDonald's with violation of Section 14(a) of the Exchange Act as a result of "its failure to disclose that it used discretion in treating Easterbrook's termination as 'without cause' under the relevant compensation plan documents," after determining that he violated the Standards of Business Conduct, leading to his retention of millions in equity compensation. The Order outlined a number of specific requirements that, in the SEC's view, called for more complete disclosure about the circumstances of the payment to Easterbrook. For example, the Order specifies that Item 402(b) of Reg S-K requires that CD&A "shall explain all material elements of the registrant's compensation of the named executive officers." (SEC emphasis added.) In addition, the Order highlights, the instructions to Item 402(b) require, among other things, a discussion of "specific decisions that were made or steps that were taken that could affect a fair understanding of the named executive officer's compensation," such as "factors considered in decisions to increase or decrease compensation materially." And, in connection with termination agreements, the Order indicates, the company must disclose the "basis for selecting particular events as triggering payment (e.g., the rationale for providing a single trigger for payment in the event of a change-in-control), as well as, under Item 402(j)(5), any "material factors" regarding a "contract, agreement, plan or arrangement . . . that provides for payment(s) to a named executive officer at, following, or in connection with any termination." In view of its remediation efforts and cooperation with the SEC—providing documents and testimony and suing to claw back Easterbrook's compensation—the SEC did not impose a civil penalty on McDonald's.

In their dissent, Peirce and Uyeda said that they were unable to support the charges against McDonald's. They viewed McDonald's as "the victim of Mr. Easterbrook's deception," not as a "securities law violator," contending that the SEC invoked "a novel interpretation of the Commission's expansive executive compensation disclosure requirements." They were concerned that the SEC's action "creates a slippery slope that may expand Item 402's disclosure requirements into unintended areas—a form of regulatory expansion through enforcement." In their view, since the requirement for CD&A was adopted in 2006, a standard industry practice had developed for the principles-based disclosure requirements of CD&A. However, they contended, "[p]roviding disclosure pursuant to Item 402(b) and (j)(5) based on the facts in this action appears to fall outside of this industry practice." In addition, they viewed the case as one of first impression in its particular application of Item 402. Notably, they considered the SEC's interpretation as outside the ambit of the rule: the Order, they argued,

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