A Year-End Reporting Question: Does a Material Weakness Mean the Financial Statements Are Misstated?

On December 11, 2018, the SEC announced settled chargesagainst a natural and organic food company, Hain Celestial Group.  The company’s problems began when members of the company’s finance group discovered that its sales organization had been offering unauthorized incentives to two major customers.  These incentives induced the customers to accept shipments near quarter-end that helped the sales department meet internal sales goals.

When the finance department discovered these unauthorized practices they began an investigation and appropriately involved the company’s audit committee.  In August 2016, when the company determined that the amount involved was likely material, they self-reported the problem to the SEC.  On the same day they announced the problem to the public and indicated they would not be able to file their SEC reports until an appropriate investigation could be completed.

The company did not file periodic reports until June 2017, at which time they filed their 10-K and also caught up their 10-Qs.  One very interesting aspect of the reports is that the company determined that there were no material misstatements in any prior periods.  The 10-K they filed had no restated financial statements.  That said, the company concluded that there was in fact a material weakness in internal control over financial reporting.

This clearly makes sense. The existence of a material weakness does not mean that a material error has occurred.  It means, as the definition of a material weakness states, that there “is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis.”  The risk a misstatement will not be detected is different from the risk that a misstatement will occur.

You can read the Form 10-K with the related disclosures here.

As always, your thoughts and comments are welcome!

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