Well, that is a most curious headline isn’t it?
These pages have long highlighted SEC enforcement actions that charge or find violations of the FCPA’s books and records and internal controls provisions – yet have nothing to do with foreign bribery.
For lack of a better term, these pages have long called such enforcement actions “non-FCPA, FCPA enforcement actions” and these enforcement actions have long been highlighted to emphasize the point that – because of the books and records and internal controls provisions – the FCPA has long been a law much broader than its name suggests.
Recently, both toy maker Mattel and cannabis company Cronos resolved enforcement actions implicating the books and records and internal controls provisions.
Mattel
This recent SEC administrative action finds in summary fashion:
“On August 8, 2019, Mattel disclosed in a Form 8-K that it was made aware of an anonymous whistleblower letter. The letter alleged accounting errors and questioned the independence of Joshua Abrahams (“Abrahams”), the then-lead engagement partner for Mattel with the company’s outside audit firm, PricewaterhouseCoopers LLP (“PwC”). Mattel terminated its pending $250 million senior notes offering, and its audit committee initiated an independent internal investigation. The audit committee’s investigation concluded that there were material misstatements in the tax-related valuation allowance for Q3 2017, which was understated by $109 million, and in the tax expense for Q4 2017, which was overstated by $109 million. The valuation allowance was understated in Q3 because Mattel’s Thomas the Tank Engine asset (“Thomas”) was erroneously treated for purposes of the valuation allowance calculation as a definite-lived asset that should be amortized, whereas at the time it was classified as an indefinite-lived asset on Mattel’s balance sheet. The audit committee also concluded that Abrahams violated auditor independence rules. The audit committee did not find that management had engaged in fraud.
On October 29, 2019, Mattel announced that it would restate its financial results for Q3 and Q4 2017. Because the Q3 understatement and Q4 overstatement self-corrected the error for the fiscal year ended December 31, 2017, the FYE 2017 financial statements did not need to be restated. Mattel’s Form 10-K/A, filed on November 12, 2019, disclosed that the Q3 and Q4 financials were materially misstated and that, as a result of the $109 million misstatement, Mattel’s Q3 2017 provision for income taxes was understated by 14%, and net loss and net loss per share were understated by 15%. Additionally, Mattel’s Q4 2017 provision for income taxes was overstated by 62%, and net loss and net loss per share were overstated by 63% for that period.
Mattel’s Form 10-K/A also disclosed two material weaknesses in internal control over financial reporting related to the error: (1) failure to design and operate an internal control over the review of the income tax valuation allowance analysis (calculation), which was remediated by December 31, 2018; and (2) failure to design and operate internal controls to properly assess and communicate known financial statement errors and internal control deficiencies in a timely manner to those parties responsible for taking corrective action, including, for example, the CEO and board of directors, which was remediated as of December 31, 2019. In addition, Mattel disclosed that its outside auditor had restated its report on internal control over financial reporting and issued an adverse opinion.”
Based on the above, the SEC found that Mattel violated, among other things, the books and records and internal controls provisions of the FCPA. Without admitting or denying the SEC’s findings, Mattel agreed to a cease-and-desist order and agreed to pay a $3.5 million civil penalty.
Cronos
This recent SEC administrative action against the Canadian cannabis company finds in summary fashion:
“This matter concerns accounting violations by Cronos … which occurred in its first years operating as a U.S. publicly-traded issuer. In 2019, shortly after becoming subject to SEC reporting requirements, Cronos embarked on a significant business expansion, seeking to enter the nascent cannabis vaporizer market. Cronos, however, lacked the requisite familiarity with applicable accounting requirements as well as the appropriate internal accounting controls to prepare financial reports that complied with U.S. reporting requirements.
Between 2019 and 2021, Cronos furnished to and/or filed with the Commission, financial statements in three separate quarters that contained material accounting errors. In two of the three quarters—the first quarter of 2019 and the third quarter of 2019—Cronos improperly recognized revenue in connection with certain transactions with the same counter-party where the sale of cannabis raw materials (or cannabis flower) by Cronos occurred simultaneously with the purchase by Cronos of processed cannabis product. Separately, in the third quarter of 2019, a since terminated senior executive of Cronos entered into an undisclosed oral agreement with a different counter-party to sell cannabis raw material to the counter-party but then repurchase the cannabis product, either as a derivative product or in some other form, in the following quarter. This oral repurchase agreement made it inappropriate for Cronos to recognize revenue in connection with the sale transaction. Finally, in the second quarter of 2021, Cronos failed to timely record impairment charges in connection with goodwill and intangible assets associated with its U.S. reporting unit. As a result of the foregoing accounting errors, Cronos furnished to and/or filed with the Commission, periodic reports that contained materially inaccurate financial statements.
After discovering the accounting errors, Cronos filed restated financial statements for the relevant quarters. In connection with the first and third quarters of 2019, Cronos disclosed that it had materially overstated its revenue by $5.8 million. In connection with the second quarter of 2021, Cronos disclosed that it should have recorded approximately $234.9 million in impairment charges in relation to its U.S. reporting unit. Concerning all three quarters, Cronos disclosed that it had identified material weaknesses in its internal control over financial reporting.”
Based on the above, the SEC charged Cronos with (among other things) violations of the books and records and internal controls provisions of the FCPA. Without admitting or denying the SEC’s findings, Cronos agreed to cease and desist from future violations.
