Of Broken Leases And ‘Broken Windows’

On Dec. 3, 2014, the Division of Enforcement of the U.S. Securities and Exchange Commission brought an enforcement action against two former top executives of Assisted Living Concepts LLC, a large provider of senior living residences based in Wisconsin, alleging the executives had schemed to hide ALC's breach of a lease covering several of its more than 200 facilities.1

According to the SEC Division of Enforcement's order instituting proceedings ("order"), when former CEO Laurie Bebo and former Chief Financial Officer John Buono realized that ALC was not maintaining a contractually required level of resident occupancies in a few of its senior facilities, which could have allowed its landlord to declare a lease default and pursue liquidated damages, they directed accounting personnel to inflate resident counts in documents ALC provided to the landlord.

The SEC claims that Bebo and Buono fooled the landlord by listing ALC employees and fabricated individuals as senior residents to boost reported occupancies. Further, the SEC claims that Bebo and Buono signed audit certifications given to ALC's independent audit firm where they falsely attested that ALC was in compliance with all contractual agreements.

Significantly, while the SEC's blaring headline announcing the case — "SEC Announces Fraud Charges Against Two Executives in Scheme Involving Fake Occupants at Senior Residences" — suggests that ALC somehow fraudulently inflated its publicly reported financial numbers, it did not.2 Indeed, the SEC's order makes clear that while ALC included quarterly revenue for the allegedly "fake" residents in documents it gave its landlord, it later reversed that revenue and did not include such revenue in its SEC filings or in other public statements.

Instead, the SEC's fraud claim rests upon the allegation that ALC's periodic filings were materially misleading to its investors because the company falsely represented in its 10-Ks and 10-Qs that it was in compliance with the lease covenants, and failed to properly disclose a loss contingency after it triggered the lease default provisions.

Seen as a fraud case, the SEC's allegations seem a bit of a stretch, turning what is foundationally a breached contract into a full-blown Section 10(b) securities fraud claim. As the SEC order notes, the lease at issue covered only eight out of more than 200 facilities run by ALC, and thus it is not at all clear that investors would have cared if ALC breached the lease and became subject to accelerated payment terms.

But seen as a case about top executives deliberately creating false corporate documents and lying about it to the...