All posts by George Wilson

It Is “Déjà vu All Over Again” – Another SEC Channel Stuffing Enforcement

Hot Topic

In this October 2020 post, we reviewed an SEC enforcement case involving HP Inc.  That case focused on HP “pushing” inventory into its distribution channels and eventually surprising investors with an unexpected revenue shortfall when channels could not accept any more inventory.  The déjà vu in that post was remembering back to a very similar “gallon pushing” enforcement involving Coca-Cola.

The “déjà vu all over again” (and thanks Yogi Berra!) in this post is about a May 3, 2021 case involving Under Armour.  This Accounting and Auditing Enforcement Release (AAER) tells an eerily similar story to the HP Inc. and Coca-Cola cases.

In mid-2015, Under Armour’s FP&A group determined that the company’s forecasted revenue growth rate would not meet internal targets or analysts’ expectations.  This forecasted revenue shortfall was a major concern for Under Armour management.  Under Armour had reported year-over-year revenue growth of over 20% for 26 consecutive quarters.  Management consistently emphasized this growth rate in its communications with investors and analysts.

Under this pressure to maintain the 20% revenue growth rate, according to the AAER, “Under Armour’s senior management directed the FP&A group and senior sales personnel, among other things, to identify existing orders that customers had requested be shipped in the next quarter that could instead be shipped in the current quarter.”  This began a six-quarter process of “pulling forward” customer orders to increase revenues to meet analysts’ expectations.

As you would expect, and just as happened in the HP Inc. and Coca-Cola cases, this robbing Peter to pay Paul process could not continue forever.  According to the AAER, “[o]n January 31, 2017, Under Armour announced revenue of $1.308 billion for the fourth quarter of 2016, which reflected year-over-year revenue growth of 12%.  Under Armour did not meet analysts’ revenue estimates for the fourth quarter of 2016, and it did not report year-over-year revenue growth of over 20%. That day, the company’s stock price dropped by approximately 23%.”

A 23% stock price drop provides clear evidence that the failure to meet revenue forecasts was material information. And while this is evidence viewed with 20-20 hindsight, it seems likely management was aware that this was material information.

When management knows there is a potential problem on the horizon (failing to meet sales growth expectations in this case), the S-K Item 303 known-trend requirements in MD&A require that companies disclose:

“any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations.”

In addition, Instruction 3 to S-K Item 303(a) requires that within MD&A:

“discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition.”

The AAER states:

“Under Armour’s use of pull forwards created an uncertainty or event that was known to Under Armour’s senior management and was reasonably expected to have a material effect on the registrant’s future revenues. Under Armour’s failure to attribute growth in revenue to the use of pull forwards did not provide investors with material information about its revenue necessary for an understanding of its results of operations. As a consequence, Under Armour violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13, and 12b-20 thereunder.”

There are other important legal issues in this case.  In the AAER, the SEC states that Under Armour violated the provisions of both the 1933 and 1934 Acts:

“As a result of the conduct described above, Under Armour violated Section 17(a)(2) and (3) of the Securities Act, which prohibit any person from directly or indirectly obtaining money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or engaging in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser, in the offer or sale of securities. A violation of these provisions does not require scienter and may rest on a finding of negligence. See Aaron v. SEC, 446 U.S. 680, 685, 701-02 (1980).”

“Also as a result of the conduct described above, Under Armour violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, and 13a-13 thereunder, which require reporting companies to file with the Commission complete and accurate annual, current, and quarterly reports. Under Armour also violated Rule 12b-20 of the Exchange Act, which requires an issuer to include in a statement or report filed with the Commission any information necessary to make the required statements in the filing not materially misleading.”

One important aspect of this case surrounds revenue recognition accounting.  There was no issue with how and when Under Armour recognized revenue.  No accounting issues were raised in the AAER.  The enforcement is all about disclosure.

Under Armour entered into a Cease and Desist Order and paid a $9,000,000 fine.

As always, your thoughts and comments are welcome!

SEC Institute Training Schedule – Spring, Summer and Fall Overview

About SECI

With the end of second quarter 2021 approaching and the necessity of implementing the SEC’s November 2020 MD&A and related changes looming, we thought it would be helpful to provide an overview of our current SEC Institute curriculum.  SECI’s 2021 curriculum includes conferences (“Forums”), Essentials Workshops, traditional Workshops and On-Demand content.

FORUMS

SECI’s Forums are two-day conferences that feature expert speakers addressing SEC reporting, FASB and other key developments.  In June and September 2021, our conferences will be Webcast only.  In December 2021, we are offering a live in-person option as well as a Webcast.

36th Midyear SEC Reporting & FASB Forum – Webcast

June 10-11, 2021 (EDT)

June 17-18, 2021 (PDT)

17th Annual SEC Reporting & FASB Forum for Mid-sized & Smaller Companies – Webcast

September 13-14, 2021 (PDT)

37th Annual SEC Reporting & FASB Forum – Live in person & Webcast

December 2-3, 2021 (PDT)

December 13-14, 2021 (EDT)

ESSENTIALS WORKSHOPS

Our new Essentials Workshops are virtual-only, half-day programs delivered via Zoom to provide enhanced participant involvement and engagement.  They feature small class sizes and deep dives into specific areas and topics.  Each program is offered multiple times during the year.  You can find the dates and related agendas for each program module using the links below:

SEC 101 Reporting Essentials for Lawyers Workshop

SEC 101 Reporting Essentials for Financial Professionals Workshop

Form 10-K SEC Reporting Essentials Workshop

MD&A SEC Reporting Essentials Workshop

Form 8-K SEC Reporting Essentials Workshop

Form 10-Q, Form 8-K and Proxy Disclosures SEC Reporting Essentials Workshop

SEC 10-K Disclosure Best Practices Essentials Workshop (two half days)

 

TRADITIONAL WORKSHOPS

Our traditional SEC Reporting Skills and other in-depth Workshops are SECI’s one- and two-day intensive courses, offered at various times throughout the year.  They feature small class sizes to facilitate discussion and deep dives into the technical and more complex issues in SEC reporting and accounting.  Typically, SECI’s Workshops are offered live in-person and via Webcast.  Starting in October 2021, SECI will again be offering the live in-person option at our Conference Centers in New York and California.  You can find the dates and related agendas for each program using the links below:

Two-Day Workshops:

SEC Reporting and Practice Skills Workshop for Lawyers

SEC Reporting Skills Workshop for Financial Professionals

Form 10-K In-Depth Workshop

Form 20-F In-Depth Workshop

One-Day Workshops:

MD&A In-Depth Workshop

Accounting for Business Combinations Workshop

ON-DEMAND/RECORDED PROGRAMS

We also offer several on-demand and recorded programs featuring subjects such as ESG reporting, ethics, and materiality.  You can find them all here, and look for the “Load More” button at the bottom of the list for additional content.

PCAOB Provides Insights Into the 2021 Inspection Process

Hot Topic, Reporting

On April 6, 2021, the PCAOB published two documents addressing 2021 inspections:

Audit Committee Resource – 2021 Inspections Outlook, and

Spotlight – Staff Outlook for 2021 Inspections.

While these documents are directed primarily to auditors, they provide insights to help company management avoid audit surprises and problems.

The Audit Committee Resource reinforces the PCAOB’s commitment to “seeking views and feedback from audit committees” through its outreach process.  In 2019 and 2020 the PCAOB visited with over 700 audit committee chairs.  It also provides audit committee perspectives for areas including:

  • Auditor’s Risk Assessments
  • Firms’ Quality Control Systems
  • How Firms Comply with Auditor Independence Requirements
  • Fraud Procedures
  • Critical Audit Matters
  • How Firms Implement New Auditing Standards
  • Supervision of Audits Involving Other Auditors

The Spotlight report outlines several inspection process changes and focus areas for 2021.  Changes to the inspection process will include reviewing financial reporting and audit risks posed by COVID-19 and reducing the predictability of the inspection process.  The PCAOB will select more engagements randomly and inspect more “non-traditional” audit areas.

The report outlines areas where inspections continue to find deficiencies, such as revenue and accounting estimates.  The list of other areas where the staff plans to concentrate inspection resources includes firm quality control systems, how firms comply with independence requirements, fraud procedures, critical audit matters, implementation of new auditing standards, responding to cyber threats, auditing digital assets and supervision of audits involving other auditors.  These areas are consistent with those in the Audit Committee Resource.

As always, your thoughts and comments are welcome

A Risk Factor Rewrite Example

10-K Tips, Hot Topic, Reporting

The SEC’s May 2020 risk factor disclosure modernization created a great opportunity to rethink risk factor disclosures and focus on communicating material risks.

The prior S-K disclosure requirements for risk factors included this language:

229.105 (Item 105) Risk factors.

Where appropriate, provide under the caption “Risk Factors” a discussion of the most significant factors that make an investment in the registrant or offering speculative or risky. This discussion must be concise and organized logically. Do not present risks that could apply generically to any registrant or any offering. Explain how the risk affects the registrant or the securities being offered. Set forth each risk factor under a subcaption that adequately describes the risk.

The May 2020 Final Rule revised the requirements with this language:

229.105   (Item 105) Risk factors.

(a) Where appropriate, provide under the caption “Risk Factors” a discussion of the material factors that make an investment in the registrant or offering speculative or risky. This discussion must be organized logically with relevant headings and each risk factor should be set forth under a subcaption that adequately describes the risk. The presentation of risks that could apply generically to any registrant or any offering is discouraged, but to the extent generic risk factors are presented, disclose them at the end of the risk factor section under the caption “General Risk Factors.”

(b) Concisely explain how each risk affects the registrant or the securities being offered. If the discussion is longer than 15 pages, include in the forepart of the prospectus or annual report, as applicable, a series of concise, bulleted or numbered statements that is no more than two pagessummarizing the principal factors that make an investment in the registrant or offering speculative or risky.

(Note: the entire new text of S-K Item 105 can be found here.)

Three aspects of this rule change create opportunities to rethink this disclosure:

The change in language from “significant factors” to “material factors,”

The requirement to put “generic” risk factors at the end of the discussion and use the heading “General Risk Factors,” and

The requirement to include a summary if risk factors are longer than 15 pages.

Lumen Technologies took advantage of this opportunity in a meaningful way.   In Lumen Technologies’ Form 10-K for the year-ended December 31, 2019, risk factors are on pages 20 to 48, 28 pages long.  Risks described range from “Risks Affecting Our Business” to “Other Risks.”  It would be fair to say that some of the risk factors, such as “We may not be able to compete successfully against current and future competitors” might be “risks that could apply generically to any registrant or any offering.”

After implementing the new disclosure requirements, and a major amount of work, in Lumen Technologies’ Form 10-K for the year ended December 31, 2020, risk factors are on pages 21 to 32.  This is a reduction from 28 to 11 pages!  The revised disclosures start with “Business Risks,” a simpler and more direct heading, and finish with “General Risks” as required by the new rule.  Interestingly, the General Risks are less than one page.  Competitive issues are addressed in a more tailored risk factor titled “We operate in an intensely competitive industry and existing and future competitive pressures could harm our performance.”

“We took the SEC’s changes to S-K Item 105 as an opportunity to take a fresh look at our risk factors,” said David Hamm, Associate General Counsel at Lumen Technologies. “After a robust cross-functional effort, we believe we enhanced and streamlined our risk factors while maintaining existing protections.”

Lumen Technologies’ revised presentation is more direct and clearly more investor friendly.

As always, your thoughts and comments are welcome!

A Timely Form 12b-25 Reminder from SEC Enforcement!

Reporting

On April 29, 2021, with deadlines for first-quarter reports rapidly approaching, the SEC Enforcement Division sent an important message about using Form 12b-25 to request due date extensions.  Form 12b-25 is short and simple.  And while the extensions of 15 calendar days for an annual report and 5 calendar days for a quarterly report are not particularly long, they can be helpful to avoid becoming a non-timely filer and losing Form S-3 for twelve months. Yet, like all other SEC reports, if a 12b-25 is not complete there are consequences.

The likely source of problems with 12b-25 lies in “Part III – Narrative.”  Part III provides this instruction:

State below in reasonable detail why Forms 10-K, 20-F, 11-K, 10-Q, 10-D, N-CEN, N-CSR, or the transition report or portion thereof, could not be filed within the prescribed time period.

(Attach extra Sheets if Needed)

As we discuss in our Workshops, it is important to make complete disclosures of all the reasons for any delay. One example we cite is a February 2005 enforcement case – FFP Marketing Company, Inc., Warner Williams, and Craig Scott, CPA.  In February 2002, FFP Marketing Company discovered its financial statements were materially misstated.  In a Form 12b-25 to extend the due date of its December 31, 2001 Form 10-K, the CFO/CLO failed to disclose this fact.  When the restatement came to light, the SEC enforced, sanctioned the company, and barred the CFO/CLO from SEC practice for three years.

While the FFP Marketing case was many years ago, on April 29, 2021, just before the due dates for first-quarter reports, the SEC  announced Form 12b-25 enforcement cases against eight companies.  Using data analytics, the SEC found that these companies filed Form 12b-25s that failed to disclose that “anticipated restatements” caused the delays.  Each of the companies entered into cease and desist orders and paid fines ranging from $25,000 to $50,000.

The loss of Form S-3 for twelve months, while not stated in the enforcement release, is also another likely consequence in this type of case.

As always, your thoughts and comments are welcome!

SEC Revenue Recognition Disclosure Comments

Comment of the Week, Reporting

Revenue recognition is always at or near the top of frequent SEC comment areas.  This comment letter provides two great examples.  The first asks for deeper analysis in MD&A and the second probes the company’s ASC 606 disaggregated revenue disclosures.

MD&A

This MD&A comment asks the company to disclose quantified reasons for changes in international revenues. The comment raises an interesting inconsistency in how the company discussed and analyzed changes in domestic versus international revenues.

  1. Your discussion of changes in international wholesale segment sales attributes the decrease in sales to pandemic related store closures, which does not appear to provide enough context for the changes in revenue during the periods presented. Similar to your discussion of revenue changes in domestic wholesale sales, please revise to disclose sales volume, changes in average selling price, and/or other underlying drivers for the change in international wholesale segment sales.

The company responded that it would provide incremental disclosure in future filings and provided the SEC this example disclosure:

Our international wholesale segment sales decreased $164.4 million, or 29.9%, to $385.2 million for the three months ended June 30, 2020 compared to sales of $549.6 million for the three months ended June 30, 2019. Our international wholesale sales consist of direct sales by our foreign subsidiaries, including our joint ventures, that we make to department stores and specialty retailers and to our distributors, who in turn sell to retailers in various international regions where we do not sell directly. Direct sales by our foreign subsidiaries, including our joint ventures, was $341.7 million, a decrease of $104.0 million, or 23.3%, and our distributor sales was $43.5 million, a decrease of $60.3 million or 58.1%.

The $164.4 million decrease in segment sales was due to the effects of the pandemic and related store closures impacting our wholesale and distributor customers. Substantially all of the decrease was due to a volume reduction of 29.1% in the number of units sold. The average selling price decreased 1.3%.

ASC 606 Disaggregated Revenue Disclosures

This second comment focuses on ASC 606 disaggregated revenue disclosures.  The staff noted that, from their perspective, the company did not address a key revenue driver.

  1. We note your disclosures of sales related to e-commerce channels in your MD&A discussion and on your quarterly earnings calls. We also note that sales from your e-commerce channels increased by 428.2% and were a key driver to the quarter ended June 30, 2020. Please tell us your consideration for disclosure of disaggregated revenues for your Direct-to-consumer segment by sales channel (i.e., e-commerce channel and in-store sales) pursuant to ASC 606-10-55-89 through 91. In your response, tell us the amount of e-commerce sales recognized during the periods presented and also for fiscal 2019.

In their response, the company provided a detailed analysis of the decision-making considerations in their disaggregated revenue disclosures.  While they agreed to continue to monitor this area, they did not believe that any disclosure changes were necessary.  The staff’s next letter was the closing letter.

As always, your thoughts and comments are welcome!

CorpFin Updates Guidance for Shareholder Meetings Impacted by COVID-19

Reporting

On April 9, 2021, CorpFin updated its Announcement – “Staff Guidance for Conducting Shareholder Meetings in Light of COVID-19 Concerns.”  The update addresses issues surrounding shareholder proposals when a proponent cannot attend a meeting in person.  This update did not affect existing discussions about changing the date, time or location of a meeting, virtual meetings, and delays in printing and mailing full set proxy materials.

As always, your thoughts and comments are welcome!

Disruption for SPACs – Debt versus Equity and Possible Restatements

Hot Topic, Reporting

Debt versus equity classification for complex financial instruments has caused more public company restatements over the last 15 years than almost any other issue.  SPACs almost always issue warrants in their original formation and subsequent IPO.  These warrants, as it turns out, frequently have complex features that raise debt versus equity questions.

On April 12, 2021, the Acting Director of the Division of Corporation Finance and the Acting Chief Accountant issued a statement – “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”).”

The Statement notes that the staff has recently evaluated fact patterns surrounding SPAC warrants.  It would appear that this review has found situations where SPACs may not have properly accounted for warrants and may need to restate financial statements.  It is important to remember that this complex issue depends on the specific features of each warrant.  Warrants with very similar features can have very different accounting treatments.

The Statement addresses two areas where, if SPACs did not properly apply GAAP, and the amounts involved are material, restatement would be required.  The issues focus on

  1. whether the instruments are “indexed” to the issuer’s equity, and
  2. whether certain redemption provisions could trigger a cash settlement where all equity holders do not participate equally.

The US GAAP “indexation guidance” requires a close link between the fair values of a SPAC’s warrants and equity securities.  If the warrants have features that break this relationship, they are not “indexed to the company’s stock” and must be classified as liabilities.  This technical and complex determination generally depends on the inputs to the warrant’s fair value computation.

The redemption issue focuses on whether a warrant could require a net cash settlement which is outside the control of the issuer.  This generally would require liability classification.  There is an exception to this requirement that if the holders of the warrants and all the underlying securities would receive a cash settlement, equity classification could still be appropriate.  This can be a very complex and technical determination based on the specific provisions of a warrant.

If a SPAC has issued warrants that involve these issues and did not appropriately classify the warrants as liabilities, restatement would be required if the amounts are material.

The Statement provides reminders about the restatement process, related Internal Control Over Financial reporting issues, potential requirements to file an Item 4.02 Form 8-K and communication issues related to Reg FD.

The number of SPAC restatements and the ultimate market impact will unfold in coming weeks.

As always, your thoughts and comments are welcome!