An Example of a “Simple” Failure to Disclose Why Revenues Increased Costs – NVIDIA’s $5,500,000 Penalty

Most MD&A enforcement cases focus on a complex issue, failure to disclose a known trend or uncertainty.  In these cases (e.g., Sony, SeaWorld and Under Armour), company management knows of something that is “reasonably likely” to materially affect financial performance in the future but does not disclose this information to investors in a timely manner.  This disclosure is probabilistic and subjective.

The issue in the SEC’s recent enforcement against NVIDIA was far simpler.  As detailed in this May 6, 2022, Press Release and the related SEC Order, NVIDIA Corporation failed to disclose the causal factors behind material increases in revenues in 2018.  This disclosure failure resulted in a $5,500,000 penalty.

The foundation for this case is in Regulation S-K Item 303, language that was formerly part of Financial Release 36 (No. 33-6835) and Financial Release 72 (No. 33-8350):

Where the financial statements reflect material changes from period-to-period in one or more line items, including where material changes within a line item offset one another, describe the underlying reasons for these material changes in quantitative and qualitative terms.

This disclosure, which is one of the main objectives of MD&A as articulated in S-K Item 303 and Financial Release 72, is to provide material information to help readers “ascertain that past performance is indicative of future performance.”

As you can read in the SEC Order, NVIDIA, which sells powerful computer chips know as graphics processing units (or GPUs), generated material increases in revenue in 2018.  Specifically, gaming GPU revenue increased 52% and 25% for the second and third quarters of 2018, respectively.  Company management knew that a significant part of this increase was because cryptominers were buying gaming chips, even though the company had built a separate product line for these customers.  The company was also aware that cryptomining is a very volatile business.

In its Form 10-Q for the second and third quarters for 2018, NVIDIA did not disclose that cryptomining was a significant factor in gaming revenue growth.

Not disclosing this information meant that investors did not have necessary information to “ascertain that past performance is indicative of future performance.”

The SEC Order also focuses on NVIDIA’s failure to maintain effective disclosure controls and procedures.

The CorpFin review process has consistently emphasized the requirement to disclose qualitative and quantitative information about the causal factors behind financial statement changes.  The voice of the Enforcement Division is now reinforcing this message: failure to disclose material information about causal factors behind financial statement changes can result in significant penalties.

As always, your thoughts and comments are welcome!

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