SEC Charges AI Co. Audit Cmte. Chair with Failing to Adequately Investigate Report of Financial Misdeeds, Signing 10-K Containing Fake Revenue

On September 16, 2024, the Securities and Exchange Commission (SEC) filed civil charges against former CEO Paul D. Roberts, former Chief Financial Officer Joshua A. Weiss, and former Audit Committee Chair Grainne M. Coen of AI company Kubient for their alleged role in inflating and misstating Kubient’s revenue in two public stock offerings. The same day, Roberts also pleaded guilty to one count of criminal securities fraud.

Kubient developed an AI fraud detection tool called KAI designed to detect fraud when companies buy or sell digital ad space. According to the SEC, Roberts fabricated KAI analyses for two customers as part of the beta tests. Kubient allegedly never obtained the customers’ data to perform the actual analyses and did not perform the tests for the customers. Kubient falsely stated in its public stock offerings that it received over $1.3 million in revenue for these analyses. The SEC also charged Weiss, Kubient’s former CFO, for allegedly assisting Roberts’ scheme and lying to Kubient’s outside auditors.

Outside director charged with fraud and lying to auditors

The most interesting claim by the SEC is against Coen, a former member of Kubient’s board of directors and former chair of the company’s audit committee, for her alleged role in the scheme. It is unusual, although not unprecedented, for the SEC to sue a board member of a company accused of fraud unless the board member also has an operating role at the company.¹ Thus, the balance of this Alert focuses on the SEC’s charges against Coen and her alleged actions (and inactions) forming the case against her.²

According to the SEC complaint brought against Coen, Kubient filed its secondary public offering materials on December 21, 2020, and the secondary offering was made effective the following day. Coen approved the secondary offering materials. On December 22, 2020, the day the secondary public offering became effective, a high-level employee notified Coen that the wrong data instead of the customers’ data had been scanned as part of Kubient’s crucial KAI beta test. The employee explained that Kubient might need to restate its earnings, which included $1.3 million in revenue from the beta test. Coen raised the issue with outside securities counsel that same day. However, following this discovery, Coen allegedly took a series of actions that the SEC claims advanced Roberts’ scheme.

The SEC alleges the Audit Committee Chair’s missteps following notification of the fabricated analyses and misstated revenue were:

• Coen failed to investigate whether the customers had in fact provided data for Kubient to perform the important beta product test, how Kubient could have analyzed its own data rather than the customers’ data, or whether Kubient ultimately provided any analyses to the customers.
• Upon discovery of the fabricated analyses and misstated revenue, Coen failed to correct false and misleading statements in the secondary offering materials and in Kubient’s 2020 Form 10-K.
• Coen failed to relay the information from the employee regarding the fabricated analyses and related revenue to Kubient’s independent auditors.
• Coen excluded the independent auditor from a January 7, 2021, audit committee meeting that discussed the concerns raised by the employee. Coen invited the auditor to, and the auditor attended, every other audit committee meeting between May 2020 and January 2021. Unlike the other audit committee meetings, no minutes were created. Because there were no minutes, the independent auditor was not aware that the meeting occurred.
• Coen signed minutes from the subsequent audit committee meeting, held March 19, 2021, that falsely stated that the last committee meeting occurred on November 10, 2020, rather than January 7, 2021.
• During the independent auditor’s 2020 year-end audit, Coen falsely represented that she had no knowledge of any tips or complaints regarding the company’s financial reporting, of fraud or suspected fraud affecting the company, or of other matters relevant to the audit.

Takeaways for Board Members

• When an outside board member receives information that raises serious questions about the company’s financial results, key public disclosures, or operations, the board member should take action to ensure that a proper process is initiated to investigate the claims.
• When senior management is potentially involved in the conduct that is the subject of a whistleblower report, a board member should do diligence on the report or ensure that someone independent is investigating the facts underlying the complaint.
• A board member should not participate in nor condone actions that deny the independent auditors important information that could affect the auditors’ judgment about any material aspect of the financials, the company’s disclosures, or the auditors’ views of the integrity of management.
• When confronted with allegations of potentially serious wrongdoing in connection with a company’s financial statements and disclosures, a board member should consider seeking legal advice from experienced securities counsel and should ensure that counsel has all relevant information about the allegations.
• By signing or approving any public statements, the board member can be subject to liability under the federal securities laws through SEC filings or other official disclosures, and those disclosures may provide a hook for the SEC to bring an enforcement action against the board member.

Footnotes

¹ Other SEC enforcement cases against nonexecutive board members include SEC v. Thompson, Lit. Rel. 25517(Sept. 23, 2022) (outside director); SEC v. Bailey (N.D. Florida, 2016) (outside directors); In the Matter of Shirley Kiang, Exchange Act Rel. No. 71824 (March 17, 2014) (audit committee chair ); SEC v. AgFeed Industries (March 11,2014) (audit committee chair); SEC v. Krantz (S.D. Fla., Feb. 28, 2011) (outside directors); and SEC v. Raval, 8:10-cv-00101 (D. Neb. March 15, 2010) (outside director).

² It is important to emphasize that the SEC’s complaint contains mere allegations. Indications are that Coen and Weiss are litigating the case. Often, once defendants respond in the litigation, they are able to point to conflicting or mitigating evidence that the SEC did not include in its complaint and that may tell a very different story than what’s in the complaint. Nevertheless, the SEC’s complaint is instructive because it conveys what alleged facts the Commission believes are important when it evaluates the legal responsibilities of outside directors.