Get the Numbers Right — SEC Enforcement Activity Highlights Focus on Accounting Violations, Non-GAAP Disclosures and Executive Liability

• On September 28, SEC announced charges against three former executives of New York-based telecommunications company Pareteum Corp. (“Pareteum”) for their roles in fraudulent revenue recognition practices. The executives allegedly caused Pareteum to recognize revenue for non-binding purchase orders prior to product shipment that were conditioned on the customers first being able to re-sell the services to downstream customers. The SEC alleged that these practices were contrary to GAAP and caused Pareteum to overstate its revenue by 60 percent for fiscal year 2018 and by 91 percent for the first and second quarters of 2019 combined. Criminal charges are also pending against two of the executives.
• The next day, the SEC announced charges against Georgia-based consumer products company Newell Brands Inc. (“Newell”) and its former CEO for allegedly misleading investors about Newell’s core sales growth, a non-GAAP financial measure the company touted to explain its underlying sales trends. According to the SEC, Newell inflated its core sales growth numbers from Q3 2016 through Q2 2017 by:
  • pulling sales forward from future quarters;
  • engaging in “pick and holds,” whereby Newell arranged for a third-party carrier to pick up shipments prior to quarters end, hold the goods for days or weeks, and then deliver the goods the next quarter, when the customer had requested them;
  • reducing accruals; and
  • reclassifying customer allowances as costs of goods sold rather than a reduction in revenue.

The SEC alleged that, at the same time the former CEO was describing Newell’s sales numbers to the market as “strong” and “solid,” he was describing them internally as “a massive miss.” To settle the charges, Newell and the former CEO agreed to cease and desist any further violations of the securities laws and to pay civil penalties of $12.5 million and $110,000, respectively.

Improper earnings management and accounting disclosure charges have been on the rise over the last several years since the creation of the SEC’s EPS Initiative, which uses analytics to try to pinpoint potential manipulators of publicly disclosed earnings per share.¹  According to Cornerstone Research, the number of enforcement actions involving accounting and auditing enforcement initiated by the SEC in FY 2022 increased by 55% from FY 2021, and the number of actions relating to announced restatements or material control weaknesses was the highest the SEC had initiated in recent years.

Mark Cave, Associate Director of the SEC’s Division of Enforcement, explained that “[s]enior executives of public companies hold positions of trust, and they risk abusing the duties attendant to their offices when they reach into a company’s accounting control processes as a way of making up for performance shortfalls.”² As a result, public companies and their executives must ensure that their year-end and quarterly accounting practices match their disclosures, any manual adjustments are properly analyzed and supported, and that a strong control environment is maintained. And, it is important that public companies avoid placing undue pressure on their management teams to meet interim financial targets.

¹ Jeff Johnston, Rebecca Fike & Tom Mitsch, The SEC Closes the Cookie Jar – Recent SEC Enforcement Activity Reaffirms Focus on Improper Earnings Management, V&E Insight (May 5, 2022), https://www.velaw.com/insights/the-sec-closes-the-cookie-jar-recent-sec-enforcement-activity-reaffirms-focus-on-improper-earnings-management/

² Press Release, Sec. & Exch. Comm’n, SEC Charges Newell Brands and Former CEO for Misleading Investors About Sales Performance (Sept. 29, 2023), https://www.sec.gov/news/press-release/2023-210#:~:text=%E2%80%9CSenior%20executives%20of%20public%20companies,making%20up%20for%20performance%20shortfalls.%E2%80%9D.