Blowing The Whistle On Companies That Cook The Books

Companies naturally want to project financial strength and portray themselves in the best possible light. But the pressure to do so often leads to fraudulent accounting efforts that distort their finances and mislead important stakeholders. Unscrupulous companies have been known to adopt a number of clever accounting maneuvers designed to make themselves look much healthier than they really are. This practice is colloquially referred to as cook the books.

Companies that engage in this sort of misconduct defraud the public and mislead investors. These schemes eventually collapse, but often not before raking in significant sums of ill-gotten gain. That’s why regulatory agencies, such as the Securities and Exchange Commission (SEC), have established whistleblower programs. Whistleblowers not only help put an end to these scams, but they may be eligible for a reward.

Ways Companies Cook the Books

If you know about a company that’s cooking the books, our firm can help you become a whistleblower. It starts with recognizing how companies carry out this fraud. We’ll explore some of the most common methods below.

Manipulating Revenue

This is the most common way that companies cook the books, and it is sometimes referred to as improper revenue recognition. Standard accounting rules require that revenue only be recognized once a company has earned and realized it. However, companies often shift their revenue from one earnings period to another in order to falsely meet expectations. Other times, a company has already met its target for the period but may delay reporting the revenue.

The SEC has vigorously pursued revenue manipulation cases. One such case was In the Matter of L3 Technologies, Inc. A defense and aerospace company was accused of not keeping accurate books and records, and failing to maintain proper internal accounting controls. L3 Technologies wrongly recorded nearly $18 million in revenue from a contract by generating invoices for unresolved claims. These invoices were created in the company’s internal accounting system but were not delivered to the customer. 

Another case was In the Matter of Marvell Technology Group, Ltd. Here, Marvell orchestrated a scheme to accelerate, or “pull in,” sales to the current quarter that had been scheduled for future quarters. This manipulation scheme was done to lessen the gap between actual and projected revenue and meet publicly issued revenue guidance. Concerns about cooked books were reported internally but ignored, and thereby misled investors.

False Revenue

Sometimes, a company simply makes up “revenue” through fictitious contracts and sales that don’t exist. This is typically done to inflate net income and portray the company as more profitable than it actually is. Businesses that record sham revenue often get greedy when they do so. In one SEC enforcement action, a company recorded $66 million in false earnings, which accounted for over 90% of its total reported revenue for the year.

There are even cases in which a company will create a non-existent customer from thin air. This happened in SEC v. Putnam et al., in which Anicom Inc. recorded in its financial statements millions of dollars in sales to a fictitious entity, SCL Integration.

These cases often rely upon “cookie jar” accounting. Companies make actual sales, but leave them unrecorded and saved up for later. When revenue drops, they then draw from the cookie jar to make it appear as though sales are steady.

Channel Stuffing

This happens when a company sends excess amounts of goods to distributors ahead of actual demand. Even though the distributor has the right to return unsold goods, overselling inventory in this way allows a business to artificially inflate its revenue. Channel stuffing typically happens toward the end of a reporting period when a company needs to demonstrate more revenue.

Accusations of channel stuffing are sometimes made against relatively well-known companies. For instance, in SEC v. Bristol-Myers Squibb, the biopharmaceutical giant was accused of selling excessive amounts of pharmaceutical products to wholesalers ahead of demand. That allowed the company to improperly report $1.5 billion in artificially inflated sales.

Third-Party Transactions

Cook the book schemes often involve transactions with third parties. There are a number of these that are conducive to fraud, with some of the most prominent being consignment sales, side letter agreements, bill and hold sales, and other contingency sales arrangements.

The SEC pursued an enforcement action against Alere Inc. for a third-party transaction scheme to engage in fraudulent accounting. The practice involved a bill and hold sale, also called a postponement of delivery agreement. Customers who purchased a product agreed not to take delivery of it, and it remained stored in a warehouse. However, the company recognized revenue in an earlier quarter than permitted under GAAP (Generally Accepted Accounting Principles).

Improper Management Estimates

Companies may fraudulently adjust accounting estimates or inaccurately report them, in order to impact their financial statements. To manipulate estimates, a business may prepare a fraudulent accounting model based on false assumptions. This can be done to avoid negative revenue reporting that makes the company look less profitable.

As one example from the SEC enforcement files, In the Matter of Computer Sciences Corporation et al., a company was allegedly committing widespread accounting and disclosure fraud. It included overstated earnings and hiding information from investors concerning problems with a large contract. The finance director of Computer Sciences Corporation contrived an accounting model that was based on made-up assumptions about additional revenue. The assumptions were unreasonably false and were designed to inflate profit margins.

False Expense Capitalization

One way to cook the books is to treat a company’s expenses as capital expenditures. In other words, by falsely treating the expense as an investment made to expand the business.

AOL engaged in this practice in the early 1990s when it was distributing installation CDs. Rather than treat the distributions as expenses, AOL labeled this marketing campaign a long-term investment and decided to capitalize its costs. This effectively transferred the expenses from the income statement to the balance sheet, where the marketing effort would be expended over a period of several years. That, in turn, meant the entire amount was written off the profit and loss statement and thereby artificially boosted profits. The correct accounting method for this action would have been to expense the costs when the CDs were actually shipped.

In another case, SEC v. Penn West Petroleum Ltd. et al., an oil and gas company improperly shifted hundreds of millions of dollars in costs from operating expense accounts to capital expenditure accounts. This falsely reduced the company’s operating costs, sometimes by up to 20% in certain reporting periods. Investors were thereby misled as to the true cost of an important oil extraction process.

Other Forms Of Expense Manipulation

Misstating or misreporting expenses can take a number of other forms as well, many of which are designed to artificially inflate profits. A company may eliminate or defer expenses from a current reporting period to make net profits appear higher. The company might also understate bad debt reserves, or fail to record asset impairments.

Schemes that fall into this category sometimes combine other behaviors, like those mentioned above. For instance, in SEC v. Celadon Group, Inc., a trucking shipping company used fraudulent third-party transactions to overstate its income and earnings. The business’s expense manipulation scheme recognized at least $20 million in impairment losses and charges.

Deceptive Projections And Forecasts

Investors rely on information contained in company financial statements. That information may include critical financial goals of the company. One way to cook the books is to issue deliberately misleading projections of forecasts in order to get around disclosing unfavorable information.

In the Matter of Walgreens Boots Alliance Inc. et al. is one SEC enforcement case that illustrates how these deceptive forecasts and projections work. In this matter, a company was accused of deceiving investors during a merger. During one phase of the merger, internal analyses showed a heightened risk of the company missing its yearly earnings projection. However, the company publicly reaffirmed its original projection. The scam unraveled, and the company was forced to pay a substantial sum of money in order to settle the claims of accounting fraud.

Misusing Non-GAAP Methods

A company is not necessarily required to use GAAP accounting methods if doing so would not present an accurate depiction of its finances. However, if a company uses non-GAAP metrics, it must accurately report this. Otherwise, the business might manipulate this accounting to falsely portray stronger growth or better earnings.

Since analysts and investors rely upon a company’s accounting metrics, including those that are non-GAAP, there’s a risk of misleading them along with the general public. This is what occurred in the SEC case, In the Matter of Brixmor Property Group Inc. The SEC accused Brixmor and several former executives of manipulating its non-GAAP accounting. In particular, the executives adjusted the company’s same property net operating income, a critical measure relied upon by investors to judge the worth of the business.

Insufficient Internal Controls

The SEC requires that all companies subject to its jurisdiction adopt internal accounting controls concerning financial reporting. There are a number of requirements these controls must meet. For example, these controls have to sufficiently ensure that financial transactions will be properly recorded. They must also provide that statements will be prepared in accordance with GAAP standards. Companies can run afoul of this internal accounting requirement in a number of ways.

In SEC v. Monsanto, the company was held liable for failing to maintain sufficient internal controls. Monsanto failed to account for rebates offered to retailers and distributors and did not realize costs at the same time it recorded significant revenue.

What Is The SEC Whistleblower Program Help Whistleblowers with Companies Who Cook the Books?

The SEC’s Whistleblower Program exists to financially reward individuals who step forward with valuable information related to accounting fraud, including that concerning cooking the book schemes. Whistleblowers can remain anonymous when they have an attorney, and can also be protected against workplace retaliation.

Not everyone can be a whistleblower, and building a compelling case isn’t easy. The SEC is busy with a number of enforcement actions and has limited resources to devote to every tip it receives. The Commission prioritizes complaints that indicate widespread fraud or run the risk of serious deception of investors and the public. Therefore, it’s vital to have an experienced whistleblower attorney who can help put together a complaint that will get the SEC’s attention.

To become a whistleblower and possibly qualify for the SEC’s reward program, the following minimum criteria must be met:

  • The whistleblower must have original information about cooking the books or other accounting fraud. “Original” means that the information cannot already be known by the SEC or the general public. However, a whistleblower can potentially qualify if he or she knows about some kind of scam that is imminent but has not actually occurred yet.
  • The information has to be voluntarily provided to the SEC. That means the whistleblower cannot be under a court order or subpoena to provide the information. If the SEC learns of a cook the book scheme on its own, or you are somehow compelled to turn over information during the course of an investigation, your claim won’t qualify.
  • The information must lead to a successful SEC enforcement action. In other words, the SEC must use the information you provide to carry out legal action that results in monetary penalties against the wrongdoing company or individual. If what you provide never leads to anything or turns out to be a dead-end, you will not be eligible for the reward program. Bear in mind that these investigations can take a considerable amount of time, so patience is key.
  • The monetary sanctions collected by the SEC must exceed $1 million. The implication is that the accounting fraud will likely be significant in order for the SEC to take action. However, if the SEC receives over $1 million in penalties, you could stand to collect between 10% and 30% of the amount.

What Determines The Actual Reward Amount for Whistleblower Cases with Companies Who Cook the Books?

For successfully blowing the whistle on a cook the book scam, you could qualify for 10-30% of the monetary sanctions. The SEC determines how much to reward the whistleblower on a case by case basis, but there are a few general factors that will influence the percentage:

  • How useful and significant the information is to the SEC
  • The degree of cooperation and assistance provided by the whistleblower and his or her attorney
  • Whether the whistleblower participated in the cook the book scheme
  • Whether the whistleblower obstructed the SEC’s investigation into the fraud
  • How prompt the whistleblower was in reporting the scam

How Can Newman & Shapiro Help Whistleblowers with Companies Who Cook the Books?

As mentioned above, the SEC has limited resources. A whistleblower claim must be particularly compelling to get the Commission’s attention and trigger an investigation. The team at Newman & Shapiro has extensive experience with a multitude of different whistleblower cases, including many that involve the SEC, accounting fraud, and efforts to cook the corporate books. These claims are not like normal lawsuits and require a good handling of the applicable laws and regulations. Also, there are a number of procedural requirements and deadlines to understand and keep up with. Failure to follow these strict rules could invalidate your claim.

When you retain us, we get to work reviewing your evidence and uncovering more that can help us build a case. We know how to assemble a whistleblower claim that will convince the SEC to get involved. Cases such as these can take a significant amount of time to bring to completion, but we stay in contact with you and the Commission to make sure progress is being made. Also, we know how to negotiate the maximum reward available to whistleblowers under the law.

Part of having a dedicated SEC whistleblower attorney is protecting the anonymity of the whistleblower, which is one role we take seriously. We also understand the various anti-retaliation laws that protect whistleblowers from being fired or otherwise punished by their employers. Your employer cannot legally fire, demote, suspend, threaten, harass, or discriminate against you for blowing the whistle on a cook the cook scheme. Anyone who suffers such retaliation can sue for reinstatement, back pay, and other damages. We help whistleblowers understand and assert their rights.

Contact Our Attorney Today About Companies Who Cook The Books And Accounting Fraud

If you have inside information about cooking the books or any form of fraudulent accounting, we want to hear from you. Our team will schedule a confidential, no-pressure consultation with you to discuss the evidence you have and review your legal options. If you retain us, we will aggressively investigate the scheme and take appropriate legal action to bring it to the SEC’s attention. Finally, we will negotiate the highest possible reward for your actions.

But don’t delay. The law rewards those who take action first, so if someone else reports the fraud it could invalidate your claim. Reach out to Newman & Shapiro to get started on your whistleblower claim today.