It Is “Déjà vu All Over Again” – Another SEC Channel Stuffing Enforcement
By George Wilson
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!