Report Improper Revenue Recognition and Qualify for an SEC Whistleblower Award
Reporting Improper Revenue Recognition to SEC
Improper revenue recognition is the most common accounting violation targeted by the SEC. A January 2021 report issued by the Anti-Fraud Collaboration analyzed over 500 SEC enforcement actions involving accounting and auditing violations filed between 2014 and mid-2019 and found the most common type of fraud was improper revenue recognition (43%), followed by reserves manipulation (28%), inventory misstatement (12%) and loan impairment deferral (8%). The report also noted that “improper revenue recognition appeared to be the most prevalent fraud scheme in almost every year, and it was among the top two fraud schemes from 2014 through mid-2019.”
In addition, a recent report issued by Cornerstone Research found that about one-third of the SEC’s accounting and auditing enforcement actions filed in 2020 involved revenue recognition violations. Notably, of the 18 SEC enforcement actions involving announcements of restatements, 15 alleged improper revenue recognition.
The most common SEC enforcement actions concerning accounting violations arise from “inaccurate representations of revenue,” which include enforcement actions for:
Fraudulent reporting of fictitious sales and overbilling schemes;
Improper timing of revenue recognition; and
Channel stuffing.
Based on the current economic environment and increased pressure on publicly traded companies to meet Wall Street’s expectations, we expect the SEC to continue or increase its efforts to root out and halt improper revenue recognition schemes. Whistleblowers can assist the SEC in these efforts and earn awards under the Dodd-Frank Act’s SEC Whistleblower Program. Since 2012, the SEC has issued more than $1.2 billion in awards to whistleblowers.
SEC Whistleblower Rewards for Reporting Improper Revenue Recognition
Under the SEC Whistleblower Program, whistleblowers may be eligible for monetary awards when they voluntarily provide the SEC with original information about violations of federal securities laws – such as reporting an improper revenue recognition scheme – that leads to a successful enforcement action resulting in monetary sanctions in excess of $1 million. A whistleblower may receive an award of between 10% and 30% of the monetary sanctions collected in the successful enforcement action.
The SEC Whistleblower Program allows whistleblowers to submit tips anonymously to the SEC if they are represented by an attorney in connection with their tip. Experienced SEC whistleblower attorneys can skillfully guide whistleblowers through the process, maximizing the likelihood that they not only obtain, but maximize, their potential awards and protect their identities.
Whistleblower Tips Aid the SEC in Identifying and Halting Improper Revenue Recognition Schemes
Whistleblower tips related to violations in corporate disclosures and financials (e.g., a whistleblower tip related to a publicly traded company engaging in an improper revenue recognition scheme) have consistently been one of the most common categories of tips submitted to the SEC. In fact, according to the SEC Whistleblower Program’s Annual Reports, the number of these tips has increased every year since the SEC Whistleblower Office opened its doors in August 2011:
2011: 51 tips related to corporate disclosures and financials
2012: 547 tips related to corporate disclosures and financials
2013: 557 tips related to corporate disclosures and financials
2014: 610 tips related to corporate disclosures and financials
2015: 687 tips related to corporate disclosures and financials
2016: 938 tips related to corporate disclosures and financials
2017: 954 tips related to corporate disclosures and financials
2018: 983 tips related to corporate disclosures and financials
2019: 1,107 tips related to corporate disclosures and financials
2020: 1,710 tips related to corporate disclosures and financials
2021: 1,913 tips related to corporate disclosures and financials
SEC Enforcement Actions for Improper Revenue Recognition
Improper revenue recognition schemes often share common characteristics. Indeed, most of the schemes targeted by the SEC include: 1) fictitious sales or fraudulent overbilling; 2) improper timing of revenue recognition; and 3) channel stuffing – sending customers more inventory than they can be expected to sell to inflate sales figures. The following SEC enforcement actions are examples of the types of improper revenue recognition schemes that could result in an SEC whistleblower award:
1) Fictitious Sales and Fraudulent Overbilling
SEC v. Maxwell Technologies, Inc., et al.: Maxwell Technologies paid a $2.8 million penalty to settle charges that it improperly inflated its revenue by booking contingent sales of auto parts as revenue. Evidence of the scheme included falsified purchase orders and secret side arrangements to keep the scheme hidden.
SEC v. Putnam, et al.:The SEC charged the company and its directors with violating federal securities laws after the company falsely reported millions of dollars of nonexistent sales to inflate its earnings and net profits. According to the SEC’s complaint, the fraud had two aspects. First, the defendants improperly recognized numerous fictitious sales that overstated reported revenues and net profits. Second, the defendants entered journal entries that improperly reduced expenses and accelerated the recognition of sales between reporting periods.
SEC v. Garthright, et al.: The SEC charged SMF Energy Corp. and its officers with accounting fraud for inflating revenues through a fraudulent billing scheme. According to the SEC’s complaint, the billing scheme “increased the amount of gallons of fuel invoiced beyond what was actually delivered to customers,” which resulted in false and misleading disclosures in the company’s SEC filings. The billing scheme circumvented SMF Energy’s internal accounting controls and led to, among other things, materially overstated revenues, profit margins, shareholders’ equity, and net income in its SEC filings.
SEC v. MedQuist, Inc.: The SEC charged MedQuist with accounting fraud when it secretly inflated customer bills by increasing the number of lines of medical test that it purportedly transcribed. According to the SEC’s complaint, the “scheme was able to continue for several years because the unit of measure upon which bills to many customers were based . . . could not be verified by customers. Knowing that its customers were unable to verify line counts on bills, [MedQuist] . . . manipulate[d] line counts on customer bills to reach specific revenue and margin targets.” MedQuist and its Director, President, and Chief Operating Officer were charged with violating securities laws.
2) Improper Timing of Revenue Recognition
SEC v. L3 Technologies, Inc.: The SEC charged L3 for failing to maintain accurate books and records and failing to maintain adequate internal controls when the company improperly recorded $17.9 million in revenue from a contract by creating invoices associated with unresolved claims that were not delivered when the revenue was recorded. According to the SEC’s order, employees “immediately reported concerns regarding potential violations of L3’s accounting policies and internal accounting controls to L3’s internal ethics department,” but the subsequent ethics review failed to uncover the misconduct due, in part, to “a failure by ethics investigators to adequately understand the billing process.”
In the Matter of William A. Dickson and Stephen P. Collins: The SEC charged IGI Inc. with fraudulent accounting practices and reporting, inadequate internal controls, and books-and-records violations for engaging in fraudulent sales-cutoff practices and other improper accounting practices. As a result of the improper sales-cutoff practices, “IGI misstated its assets, revenues, and net income” for several years.
3) Channel Stuffing
SEC v. Bristol-Myers Squibb Company: Bristol-Myers Squibb Company (BMS) agreed to pay $150 million to settle charges that it sold excessive amounts of pharmaceutical products to its wholesalers ahead of demand, improperly overstating its revenues by $1.5 billion. According to the SEC’s complaint, “BMS inflated its results primarily by: (1) stuffing its distribution channels with large quantities of its pharmaceutical products ahead of demand (excess inventory) near the end of every quarter to meet sales and earnings projections set by the Company’s officers (collectively, channel stuffing); and (2) improperly recognizing upon shipment about $1.5 billion in revenue from specially incentivized consignment-like sales associated with the channel stuffing contrary to generally accepted accounting principles (GAAP).”
SEC v. McAfee, Inc.: McAfee, Inc. agreed to pay $50 million to settle charges that the company engaged in channel stuffing that resulted in the company improperly overstating its revenues by $622 million. According to the SEC’s complaint, McAfee defrauded investors into believing that it had legitimately met or exceeded its revenue projections and Wall Street earnings estimates when, in reality, McAfee had used a variety of undisclosed ploys to aggressively oversell its products to distributors in amounts that far exceeded the public’s demand for the products, i.e., channel stuff. The SEC alleged that McAfee engaged in channel stuffing through three methods: 1) McAfee offered its distributors lucrative sales incentives that included deep price discounts and rebates in an effort to persuade the distributors to continue to buy and stockpile McAfee products; 2) McAfee secretly paid distributors millions of dollars to hold the excess inventory, rather than return it to McAfee for a refund and consequent reduction in McAfee’s revenues; and 3) McAfee used an undisclosed, wholly-owned subsidiary, Net Tools, Inc., to repurchase inventory that McAfee had oversold to its distributors.
The experienced whistleblower lawyers at Zuckerman Law represent whistleblowers worldwide before the SEC under the Dodd-Frank SEC Whistleblower Program. The firm has a licensed Certified Public Accountant and Certified Fraud Examiner on staff to enhance its ability to investigate and disclose complex financial fraud to the SEC, and two of the firm’s attorneys served on the Department of Labor’s Whistleblower Protection Advisory Committee and in senior leadership positions at a government agency that protects whistleblowers.
