Lost Money On K12 Shares In Late 2013? Wait Until You See What Management Kept From You...It's Not Pretty
K12 Crushed Investors in Late 2013 Not Long After a Sweeping Undisclosed Formal SEC Probe
K12 Claims 55 boxes of Related Docs Are Still Secret
This report was originally posted to the Probes Reporter website on 18-Dec-2014.
As a reminder, at present, this report is posted in real-time for free. In the future, Probes Reporter will become a paid subscription service. As we move toward a paid service, you should expect both timing and access to our content that you enjoy today for free will gradually change.
Summary: K12 Inc. (NYSE: LRN) was involved in a sizable - and undisclosed - formal SEC investigation in 2012-13 it definitely does not want you to know about. Worse, it appears the investigation ended shortly before the shares were crushed on news that came in late 2013 saying enrollment figures would be below expectations.
In a Formal Order of Investigation sent to the company in Jan-2012 (posted here (link is external)) the SEC demanded to interview K12 executives saying, "The Commission has information that tends to show that from at least January 1, 2011 [...] making false statements of material fact or failing to disclose material facts concerning, among other things, the academic effectiveness of K12's online public kindergarten through 12th grade school management systems." [emphasis added]
Based on what we see here, K12 and its top management definitely appear as having something to hide.
The Facts: Let us begin by observing that K12 made no clear disclosures of SEC investigative activity at any time in the time period covered by the information we reference in today's report.
We know the following --
- The first sign we found of potential problems at K12 showed up in spring 2013. In a letter dated 06-May-2013, the SEC cited the "law enforcement exemption" of the FOIA as basis to deny the public access to the detailed records we sought on this company. As a matter of law, they are acknowledging some sort of investigative activity.
- We first learned of the formal probe and related records in response to requests we filed in 2014. That's how we now know K12 was involved in a formal SEC investigation in 2012-2013.
- The formal order, dated 11-Jan-2012, includes the following allegation regarding K12: ... making false statements of material fact or failing to disclose material facts concerning, among other things, the academic effectiveness of K12's online public kindergarten through 12th grade school management systems."
- The investigation of K12 was of such scale that it generated an estimated 166,663 pages of records produced by the company and submitted to the SEC between Feb-2012 and Mar-2013. The SEC says this, "... equates to approximately 55 boxes of records that are responsive to [our] request." The company claims every single page of these documents are confidential. See below for what this means and what you can do about it.
- Ronald J. Packard, Chief Executive Officer and Founder of K12 resigned as CEO in December 2013 and as a director in June 2014. However, the company's President & COO (Timothy L. Murray), General Counsel (Howard D. Polsky), and it's CFO (James J. Rhyu) were each listed in their respective roles in each of the past two years proxy filings.
Analyst Observations: Based on what we see here, K12 and its top management definitely appear as having something to hide. As compared to other companies in our database, the sheer volume of records generated tells us K12's SEC exposure was both serious and involved. Hands-down, this probe should have been disclosed. No excuses. If we had lost money on this company late last year we'd be really angry to hear about it now.
Given the subject matter, the scale, and amount of time the SEC probe lasted, it boggles the mind to consider the contempt this management must have for investors by not disclosing. Perhaps we should be kinder and give credit for creativity on display here; that is, it surely took great contortions in logic for K12's management and attorneys to justify not disclosing a massive and formal SEC probe into a core facet of its business.
The broad claims of confidentiality further tells us this management was both careful and deliberate in doing everything they could to try to keep you from ever knowing what took place in its SEC probe. This is a gambit well-known to securities counsel (and us - again, see below for more). Through having made challenges to broad confidentiality claims made by others in the past, we are confident in saying K12's confidentiality claims are likely specious as well.
Now that we've outed them, management's story may be that the post-investigation guidance regarding enrollments is not directly related to the SEC probe. It doesn't matter. It still should have been disclosed. We might trust them more today if it was.
The only potential upside is that the Founder/CEO is now gone. A founder/CEO often has hold over the culture, tone, and ethical foundation to the companies they start. Mr. Packard easily could have been the force behind what caused the SEC probe and why it was not disclosed to investors. Until the SEC provides us with more records, or until documents claimed as confidential are made public, investors will never know what Mr. Packard's role was in the matter under investigation. We suspect it wasn't pretty.
But make no mistake: All three of the executives we named here deserve to be held accountable for the cause and subsequent secrecy surrounding K12's formal SEC probe. K12's President & COO (Timothy L. Murray), General Counsel (Howard D. Polsky), and it's CFO (James J. Rhyu) were each listed in their respective roles in each of the past two years proxy filings.
Finally, it's worth nothing that the SEC enables the shoddy disclosure practices we outlined here. One way they do this by consistently denying the public access to reports it routinely prepares that summarize why an investigation was opened, the work performed and the conclusions reached. If the SEC simply complied with the FOIA by releasing these reports on its closed investigations, transparency would be improved and investors better protected.
When Confidentiality Claims Become Questionable
Our founder's work in pioneering using the FOIA as a research tool back in 2000 did not go unnoticed by the legal community. In fact, an article posted to the American Bar Association’s website, Mr. Gavin was twice referenced in a piece on, "... how best to protect documents from unnecessary release to the public." (See "The FOIA Blitzkrieg: Company documents provided to the SEC are under attack").
Consistent with tactics advocated in the above-referenced article, the company in today's report asserted the SEC’s “Rule 83” to block access to records it doesn't want you to see. The SEC’s Rule 83 allows companies to initially get away with making what are essentially unlimited confidentiality claims without substantiation. The Rule states, in part, that:
“The requester [the company featured in this report] may claim personal or business confidentiality, but need not substantiate his or her request until the FOIA Office notifies him of a FOIA request for the records.”
In other words, a company wishing to hide details on an SEC investigation may simply claim that something is confidential, and is only required to substantiate the need for secrecy after the documents have been requested through a FOIA request, as was done by us.
When a public company uses Rule 83 to make sweeping, yet unsubstantiated, confidentiality claims we say they are playing the Confidentiality Game.
The "Confidentiality Game"
We've seen many companies make claims of confidentiality in the past. What’s unusual is the large volume of records on which this company asserts confidentiality. It’s not often we see public companies make such broad, blanket claims.
We know from experience that legitimate claims of confidentiality tend to be specific and limited in scope. On this basis alone, it strains credibility to believe every single one of the pages of records claimed as “confidential” truly is.
For example, Apple might legitimately seek confidential protection so that the details of its contract with AT&T did not become known to the world. The Freedom of Information Act (FOIA) generally views the hypothetical Apple-type of request for confidentiality as reasonable; we’ve seen others make requests like this; they typically result in an order granting confidential protection; and, challenging such orders is rarely successful. This is also the case with trade secrets and sensitive personal information about employees.
The Dirty Secret To The Confidentiality Game
Any investor has the right to challenge an overbroad or unsubstantiated Rule 83 request for secrecy. If challenged, the public company knows the SEC will likely release most of those same records anyway. That's because the standards for substantiating a confidentiality claim, once challenged, are actually quite high.
But public companies also know that mounting a challenge can be expensive and, more importantly to investors, can easily take up to two years – or even longer. We call this the dirty secret to the confidentiality game.
Again, public companies playing the confidentiality game count on the fact most people don't even know they can challenge a confidentiality claim, will find it too daunting to start, or they simply give up. Probes Reporter is not one of them.
We are firm in our conviction that investors are generally best protected if SEC investigations are disclosed and overbroad and sweeping claims of confidentiality, whether made by the SEC or those it allegedly regulates, are properly challenged. As such, we already filed a challenge with the SEC.
The company in today's report must now prove the documents it claims as confidential really are. Given the sheer volume of records this company claimed as confidential, it will also likely cost it untold thousands to do so. Some may say these are expenses this company could, and should, have avoided by being more transparent in the first place. We concur.
Notes: The SEC did not disclose the details on investigations referenced above. The SEC reminds us that its assertion of the law enforcement exemption should not be construed as an indication by the Commission or its staff that any violations of law have occurred with respect to any person, entity, or security. New SEC investigative activity could theoretically begin or end after the date covered by this latest information which would not be reflected here.
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