Last month, Cornerstone Research told us that accounting and auditing enforcement activity by the SEC in FY 2022 increased by 55% over the prior fiscal year to 68 enforcement actions, 25 of which alleged improper revenue recognition.    Among the actions involving accounting restatements, 63% involved allegations regarding revenue recognition and internal control over financial reporting.  We also saw a steep increase in actions against individuals, reportedly reflecting the emphasis of SEC Chair Gary Gensler on imposing individual accountability. (See this PubCo post.)  With this new SEC Order charging USA Technologies, Inc., now known as …er… Cantaloupe, Inc.—clearly someone’s favorite fruit—with improper revenue recognition practices and ICFR violations, the SEC continues that trend.  For their roles participating in these improper activities, the SEC also brought actions against USAT’s former VP of Sales and Marketing and its former Chief Services Officer

USAT is a manufacturer and distributor of cashless payment devices and generates most of its revenues from the “sale or lease of its point of sale electronic payment devices and accompanying license, transaction and service fees.” According to the SEC Order, in the fourth quarter of FY 2017 through the third quarter of FY 2018, USAT sought “to maximize end-of-quarter revenue and meet internal sales targets” by entering into purported “bill-and-hold” sales transactions that did not satisfy GAAP criteria or USAT’s own policies and by deliberately shipping to its customers devices the customers had not ordered or had explicitly declined.

More specifically, on two occasions just prior to the end of two fiscal quarters,  “USAT recognized revenue from uncompleted sales as if they were bona fide ‘bill and hold’ transactions.  That is, USAT would ‘bill’ its customers for payment (sending a bill that it did not expect to collect upon until after delivery) and would ‘hold’ the devices, if it even had them in stock, for future delivery (often at some indefinite date).”  However, the SEC alleged, these transactions did not satisfy the GAAP criteria to recognize revenue from bona fide bill-and-hold transactions.  For example, among the GAAP requirements is that “the buyer make[] a fixed commitment to purchase the goods,” that “the buyer, not the seller, request[] that the transaction be on a bill and hold basis,” and that “the buyer ha[ve] a substantial business purpose for the bill and hold arrangement.” But, in these cases, the SEC alleged, to meet sales projections, “USAT initiated the bill and hold treatment, not the customer; the customers did not have a fixed commitment to purchase the goods in light of nonstandard, flexible payment terms and/or return policy; and the transactions lacked a fixed delivery date.”  Accordingly, the SEC charged, USAT improperly recognized approximately $1.17 million in revenue, about one-quarter of the total amount of its restated revenue.  Further, the SEC alleged, USAT did not publicly disclose its use of bill-and-hold transactions, nor did it have a written policy regarding their use.

In addition, the SEC alleged, in light of a shortage of certain devices, USAT tried to convince customers to order other unwanted but in-stock devices, on the understanding that the devices could be exchanged for the out-of-stock product without penalty when the company received new inventory.  In one example, the customer acquiesced to the proposed transaction, but, the SEC alleged, “never intended to accept delivery—a fact that was known to certain USAT executives.  In fact, USAT shipped the devices to a third party who held the devices until returning them to USAT during the following quarter.  These two transactions resulted in approximately $1.497 million in improperly recognized revenue for the second quarter of FY 2018.” In a similar transaction, again facing an inventory shortage, USAT substituted an unwanted product in a shipment to a customer, recognized the revenue, characterized the shipment to the customer as “shipping error” and accepted return the following quarter.  According to the SEC, USAT “improperly recorded revenue because it expected that the shipped devices would be returned by their customers when inventory of a different product became available.  For this reason, USAT had not completed its sale and could not properly realize income at the time of shipment.”

Ultimately, the audit committee conducted an internal investigation, which led to a restatement.  The restatement showed that USAT “overstated revenue by $2.56 million, or 2.53%, for FY 2017, and an additional $2.05 million cumulatively for first three quarters of FY 2018, resulting in a total overstatement of $4.61 million or 3.5%, for the entire period.” In its restatement, USAT included a number of acknowledgments:

“(a) pressure to achieve sales targets gave rise to the premature and/or inappropriate recognition of revenues, typically occurring at or near the end of financial reporting periods; (b) on multiple occasions, the Company’s finance function was not timely or fully apprised of the salient transaction terms in order to permit them to properly evaluate the accounting treatment of a given transaction; and (c) the Company’s internal controls failed and/or were not adequate to ensure that there was effective communication between the sales and finance functions of the Company so as to allow proper and timely evaluation of the accounting treatment of the examined transactions.  The Company also acknowledged that senior management did not timely or fully report or investigate certain employee concerns relating to compliance or financial reporting matters.”

As a result of its problematic accounting, the SEC charged, USAT made material misstatements in its annual and quarterly financial statements, as well as in a prospectus for a May 2018 public offering, which incorporated those financial statements. 

In the Order, the SEC charged USAT with violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act (obtaining money or property by means of an untrue statement or omission or engaging in a fraudulent or deceitful transaction, practice or course of business), Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11 and 13a-13 thereunder (misleading periodic and current reports), and Sections 13(b)(2)(A) (books and records) and 13(b)(2)(B) (internal accounting controls) of the Exchange Act. The SEC took into account USAT’s cooperation, including self-reporting and remedial measures.  USAT agreed to pay a civil penalty of $1.5 million.

Two executives who were alleged to have participated in and facilitated USAT’s efforts to maximize end-of-quarter revenue and meet internal sales targets were also charged. Among other things, the SEC alleged that the executives participated in the effort to persuade the customer to purchase devices it did not then need and facilitated a plan to temporarily ship the devices to a third party. The SEC also alleged that they failed to comply with the company’s internal accounting control that required contract signers to notify USAT’s Controller of any unusual terms and conditions or customer arrangements at the time of signing.  The executives, both of whom received cash bonuses partially based on the improperly recognized revenue, also signed internal certifications regarding USAT’s financial statements, but failed to apprise the Finance Department of the transaction terms known to them to permit proper accounting treatment. The VP was required to pay just under $27,000, including a civil penalty, disgorgement and prejudgment interest. The Chief Services Officer was required to pay a civil penalty of $75,000.

For more information about securities litigation, see the Cooley Securities Litigation + Enforcement blog.

Posted by Cydney Posner