Sec. & Exch. Comm'n v. Sequential Brands Grp., 20-CV-10471 (JPO)

• Decision Date: 30 September 2021
• Docket Number: 20-CV-10471 (JPO)
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. SEQUENTIAL BRANDS GROUP, INC., Defendant.
• Court: U.S. District Court — Southern District of New York

SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
v.
SEQUENTIAL BRANDS GROUP, INC., Defendant.

No. 20-CV-10471 (JPO)

United States District Court, S.D. New York

September 30, 2021

OPINION AND ORDER

J. PAUL OETKEN, DISTRICT JUDGE

The United States Securities and Exchange Commission (“SEC”) brought this action against Sequential Brands Group, Inc. (“Sequential”), alleging that Sequential engaged in negligence-based fraud when it failed to consider evidence of likely goodwill impairment. As a result, the SEC asserts violations of Section 17(a)(3) of the Securities Act, 15 U.S.C. § 77q(a)(3); Section 13(a) of the Exchange Act, 15 U.S.C. § 78m(a), and Rules 12b-20, 13a-1, 13a-11, and 13a-13 promulgated thereunder, 17 C.F.R. §§ 240.12b-20, 13a-1, 13a-11, and 13a-13; Section 13(b)(2)(A) of the Exchange Act, 15 U.S.C. § 78m(b)(2)(A); and Section 13(b)(2)(B) of the Exchange Act, 15 U.S.C. § 78m(b)(2)(B). Sequential moves to dismiss the complaint for failure to state a claim. For the reasons that follow, Sequential's motion to dismiss is denied.

I. Background

A. Factual Background

Sequential Brands Group, Inc. is a publicly traded “New York-based brand management company.” (Dkt. No. 1 (“Compl”) ¶ 1.) It “owns and manages a portfolio of consumer brands and promotes, markets, and licenses those brands through retailers, wholesalers, and distributors in the United States and abroad.” (Compl. ¶ 45.) Because Sequential acquired these consumer brands through acquisitions, it has “substantial goodwill on its balance sheet.” (Compl. ¶ 46.)

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“Goodwill” is “an intangible asset” that represents “the portion of the purchase price that is higher than the sum of the net fair value of all of the assets purchased in the acquisition and the liabilities assumed in the process.” (Compl. ¶ 5.) It reflects, for example, the “value of a company's brand name, customer base, customer relations, employee relations, and proprietary technology.” (Compl. ¶ 5.) A goodwill impairment reflects “a permanent decline in the value” of goodwill. (Compl. ¶ 5.) It is “an accounting charge that companies record when goodwill's carrying amount on the financial statements exceeds its implied fair value.” (Compl. ¶ 32.)

Generally Accepted Accounting Principles (“GAAP”) require public companies like Sequential to “test goodwill for impairment at least annually, or on an interim basis when indicators, or ‘triggering events,' are present.” (Compl. ¶ 33.) Financial Accounting Standards Board's Accounting Standards Codification (“ASC”) 350 provides that goodwill shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

During the relevant time period, ASC 350 outlined “a multi-step process for assessing whether goodwill is impaired.” (Compl. ¶ 36.) Companies could “conduct a threshold qualitative assessment of goodwill as a preliminary step . . . to evaluate whether the carrying amount . . . of a reporting unit was more likely than not greater than its fair value.” (Compl. ¶ 36.) If it was, then “more rigorous quantitative testing” was required. (Compl. ¶ 36.) If it was not, then “no further assessment was necessary.” (Compl. ¶ 36.)

Alternatively, ASC 350 provided that a company could skip the “qualitative assessment and instead proceed directly to a quantitative assessment of fair value.” (Compl. ¶ 37.) If that assessment “indicated that [the company's] carrying amount likely exceeded fair value, then ASC 350 required the company to conduct further quantitative testing . . . to measure the

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magnitude of the impairment to goodwill.” (Compl. ¶ 37.) In such circumstances, “the goodwill on the financial statements [had to be] adjusted downward, with the residue recognized as an impairment loss.” (Compl. ¶ 37.)

Sequential stated in public filings that it would follow this framework. In public filings, it stated that to evaluate goodwill, it would “first assess[] qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.” (Compl. ¶ 43.) But if it “bypasses the qualitative assessment, or concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying value, it [would] then perform[] a two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of goodwill impairment to be recognized, if any.” (Compl. ¶ 43.) At the first step, it would “compare the estimated fair value of the reporting unit to the carrying value.” Sequential stated that it “consider[ed] its market capitalization (calculated as total common shares outstanding multiplied by the common equity price per share, as adjusted for a control premium factor) to represent its fair value.” (Compl. ¶ 43.) At the second step, if the fair value was less than the carrying amount, it would “calculate the implied fair value of the reporting unit goodwill to determine whether any impairment is required.” (Compl. ¶ 43.)

In the fourth quarter of 2016, Sequential conducted its annual evaluation of its goodwill as of October 1, 2016. (Compl. ¶ 62.) For that assessment, the company retained an “external valuation consultant to conduct a quantitative assessment” of fair value, using “market capitalization . . . adjusted for a control premium factor.” (Compl. ¶ 60.) The consultant assessed Sequential's market capitalization and gave Sequential a report concluding that its goodwill was not impaired. (Compl. ¶ 61.) But Sequential's “stock price had been declining for over a year” (Compl. ¶ 54), and had continued to fall after October 1, 2016 (Compl. ¶ 64), so

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upon receipt of the report, Sequential's audit committee chair asked whether the company passed the test as of December 14, 2016 (Compl. ¶ 64). In response, Sequential's senior accounting and finance personnel assessed Sequential's goodwill using the same quantitative methodology as the external valuation consultant. (Compl. ¶ 65.) That assessment showed that Sequential's fair value had fallen below the company's carrying amount by $63 million. (Compl. ¶ 65.) Sequential's senior accounting and finance personnel subsequently assessed Sequential's goodwill as of December 31, 2016. (Compl. ¶ 66.) That assessment showed that Sequential's fair value had fallen below the company's carrying amount by $96 million. (Compl. ¶ 66.)

After receiving these reports, Sequential did not share the analyses with the company's independent auditor. (Compl. ¶ 67.) Instead, Sequential's senior accounting and finance personnel conducted a further qualitative assessment to evaluate its goodwill. (Compl. ¶ 69.) As alleged, this assessment omitted several negative events related to fair value, including (i) that retail shoe sales were trending downward; (ii) that one of Sequential's key brands was in decline; (iii) that costs for that brand were substantially higher than anticipated; (iv) that bad debts were increasing; (v) that other key brands were declining; (vi) that Sequential's EBITDA had been dropping since 2014; and (vii) that Sequential had conducted two quantitative analyses that showed impairment as of December 16, 2016, and December 31, 2016. (Compl. ¶¶ 76-77.) This qualitative analysis concluded that Sequential's goodwill was not impaired. (See Compl. ¶ 77.)

The complaint alleges that Sequential subsequently made several material misstatements in public filings as a result. In Sequential's 8-K for the fourth quarter of 2016, Sequential allegedly overstated goodwill by over $100 million; overstated earnings; and understated its net losses. (Compl. ¶¶ 89-91.) Sequential allegedly did the same in its 10-K for 2016 as a whole.

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(Compl. ¶¶ 92-93.) Also, in the 10-K, although Sequential disclosed its methodology for calculating goodwill, it allegedly did not disclose that it had conducted market capitalization analyses for the fourth quarter showing that the company's carrying amount likely exceeded fair value; did not quantify the goodwill impairment based on this finding; and instead conducted a qualitative assessment that omitted the market capitalization calculation. (Compl. ¶¶ 94-96.)

The complaint further alleges that Sequential made material misstatements in its public filings for the first and second quarters of 2017. Because Sequential carried over its goodwill, and did not conduct an interim test, it allegedly overstated goodwill; overstated total assets; understated accumulated deficit; and overstated stockholders' equity. (Compl. ¶¶ 101-105, 108- 111.) It again restated its methodology for assessing goodwill. (Compl. ¶¶ 106-107, 112-113.)

The complaint also alleges that Sequential made material misstatements in its public filings for the third quarter of 2017. It alleges that Sequential “changed its goodwill impairment methodology” because it anticipated that it likely would not pass its annual goodwill impairment test “using its disclosed market capitalization, plus control premium, methodology.” (Compl. ¶¶ 114-115.). It further alleges that this new methodology reflected “discounted cash flow” as well as “subjective opinions that the market undervalued the [c]ompany.” (Compl. ¶¶ 116-117.) Using this methodology, the company found goodwill not to be impaired. (Compl. ¶ 118.) Because the company did not find an impairment, the complaint alleges that the company overstated goodwill; overstated total assets; understated accumulated deficit; and overstated stockholders' equity. (Compl. ¶¶ 120-122.) Further, the complaint alleges that the company failed to disclose that there was a difference between the fair values calculated by its market capitalization analyses and its new methodology; that its new methodology relied heavily on subjective opinion; and other related misstatements. (Compl. ¶ 124.)

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Sequential...