In this settled action, the SEC charged Newell Brands and its former CEO with providing misleading disclosure about a prominently featured non-GAAP financial measure—“core sales,” a key NGFM that Newell portrayed as providing “a more complete understanding of underlying sales trends.” As described in the Order and press release, Newell and its CEO took a number of actions—reclassifications, accrual reductions, order pull-forwards—that increased “core sales” growth, but the resulting increases “were out of step with Newell’s actual but undisclosed sales trends, allowing the company to announce ‘strong’ or ‘solid’ results in quarters it internally described as disappointing due to shortfalls in sales.” In fact, the SEC charged, Newell misled investors, depriving them of “information relevant to an accurate and complete understanding of Newell’s actual sales trends.” Moreover, in Newell’s effort to manage revenues, what began as tinkering with an NGFM metastasized into problems with GAAP accounting.  According to the Associate Director of Enforcement, the SEC found that “Newell’s former CEO issued an instruction to ‘scrub’ the company’s accruals after he learned that the company was projecting a ‘massive’ and ‘disappointing’ miss for the quarter….Senior executives of public companies hold positions of trust, and they risk abusing the duties attendant to their offices when they reach into a company’s accounting control processes as a way of making up for performance shortfalls.” Newell agreed to pay a civil penalty of $12.5 million and its CEO to pay $110,000.

Background. As described in the Order, in its earnings releases, Newell—think Rubbermaid, Elmer’s, Calphalon—emphasized its “core sales,” an NGFM that “purportedly presented ‘sales on a consistent basis’” and allowed investors “to view the company’s performance using the same tools that management uses to evaluate the company’s past performance . . . and prospects for future performance.” As calculated by Newell, “core sales” represented net sales adjusted to exclude the impact of “acquisitions, planned and completed divestitures, and foreign currency changes.” Newell promoted this measure by announcing its year-over-year core sales growth rate “as part of the headline at the top of its quarterly earnings release,” and included it in guidance to investors and analysts. 

From Q3 2016 through Q2 2017, the SEC alleged, Newell experience disappointing sales that were “inadequate to achieve management goals, including internal targets, guidance to investors, or analyst estimates.” But you would never know that from reading its earnings announcements. Instead, Newell made adjustments that gave the misleading impression that it had “achieved core sales growth in line with its targets.”

When the CEO was advised of the disappointing sales performance for Q3, he allegedly “approved plans to pull forward sales scheduled for subsequent quarters,” with employees obtaining permission from customers to deliver early. But that was not enough to hit its targets. In addition, the SEC alleged, Newell reclassified some forms of consideration payable to customers, such as freight allowances, previously classified as deductions from revenue to now be recorded as costs of goods sold or as selling, general and administrative expenses.  Although deductions from revenue reduced net sales and, therefore, core sales, amounts classified as COGS or SG&A, according to the SEC, did not affect the core sales metric. As a result, these reclassifications created the appearance of higher sales and sales growth.  And, because Newell did not make similar adjustments to the prior comparative year, core sales growth appeared even larger.  Although the CEO was advised that, in these circumstances, he “need[ed] to think about disclosure,” Newell did not disclose these adjustments. As a result, the SEC charged that Newell’s announced core sales growth in each quarter—which the company characterized as “strong” or “solid” meeting analysts’ estimates—was misleading and “did not provide an accurate or complete disclosure of ‘underlying sales trends.’”  The SEC also charged that Newell did not have adequate disclosure controls and procedures that were “reasonably designed to ensure that its disclosures regarding core sales growth were accurate and complete.”

When sales for Q4 appeared abysmal, according to the SEC, the CEO described the results as “a massive miss” and “disappointing”—and they were only partly attributable to the prior quarter’s pull-forward of sales.  To address this shortfall, the CEO allegedly instructed employees to “turn over every rock” looking for opportunities to reduce the accruals that Newell had established for the cost of customer promotional incentives, discounts and rebates. According to the Order, the CEO “outlined the negative consequences for Newell and its employees if the company did not achieve its core sales targets.”  Reducing those accruals would have the effect of increasing the quarter’s core sales, but, once again, these adjustments were not disclosed.  Instead Newell announced quarterly core sales growth that appeared to meet its guidance and that the CEO characterized as “competitive” and “very strong.”  Cores sales for Q1 2017 turned out to be similarly disappointing, but internal reporting showed that “Newell was able to achieve target core sales growth and exceed investor expectations due to accrual reductions and accounting changes that had nothing to do with underlying sales trends” and were not disclosed.

In Q2 of 2017, Newell again pulled sales forward and made the same kinds of adjustments and reclassifications, but this time, the SEC alleged, Newell also adopted some accounting changes “that were inconsistent with GAAP” and resulted in Newell’s reporting “inflated growth in its net sales and core sales.”  These accounting changes again involved reclassifications to COGS of certain consideration payable to customers, including penalties paid to customers for failing to adhere to shipping requirements and credits to compensate customers for distributing goods to individual stores, but, the SEC charged, reclassification of these types of consideration to COGS was not permitted under GAAP.  Rather, GAAP required that these amounts be deducted from revenue.  And, once again, Newell chose not to make a comparable change for the prior year, again exaggerating the “growth” in core sales.

With those changes, however, Newell’s auditor raised red flags about the improper reclassification and the failure to make a corresponding adjustment to the prior year and an audit committee member expressed concern about failure to adjust the comparative prior year.  But Newell’s adjustments were not revised and, once again, were not disclosed in the earnings release, which reported “a solid set of results.” And, in its Form 10-Q, Newell reported net sales and COGS in its financial statements reflecting the misclassification, which the SEC viewed as “material because it resulted in Newell significantly overstating year-over-year growth in net sales and failing to disclose that its actual year-over-year core sales growth was nearly flat.”

The SEC also charged that Newell improperly recognized revenue prematurely using a practice called “pick and hold.”  In that practice, employees would send shipments to customers early, but this time without their approval. Instead of delivering the shipment early, employees arranged for third parties to pick up shipments from Newell and then store them until they could be delivered on the dates requested in the next quarter.  As a result, Newell recognized revenue before it had satisfied the criteria of ASC 605.  According to the SEC, those “criteria required, among other things, that a shipment be made pursuant to an arrangement with the customer, and that the customer take title and assume the risks and rewards of ownership for delivery to occur.”

The SEC stated that, during the period, Newell sold securities.  In addition, the SEC observed, the CEO participated in the preparation and review of Newell’s SEC filings, signed Newell’s Forms 10-K and 10-Q, participated in Newell’s earnings calls, and signed management representation letters and certifications.

Violations. Among other things, the SEC charged that Newell “did not disclose that the reclassification of consideration payable to customers was a change that caused Newell’s reported net sales and financial information not to be indicative of its future operating results, and was a significant component of revenue growth necessary to understand Newell’s results of operations during the Relevant Period; that its use of pull forwards created an uncertainty that was reasonably expected to have a material effect on its future revenue and cause reported financial information not to be necessarily indicative of future operating results; or that the actions described above materially increased Newell’s publicly stated core sales and core sales growth. During the Relevant Period, Newell lacked disclosure controls and procedures that were reasonably designed to ensure that its disclosures regarding core sales growth were accurate and complete.”

The SEC charged Newell with violation of Securities Act Sections 17(a)(2) and 17(a)(3) (untrue material statements in connection with the sale of securities); Exchange Act Sections 13(a) (misleading disclosure in periodic reports, particularly the failures identified above), 13(b)(2)(A) (books and records), and 13(b)(2)(B) (internal accounting controls); Exchange Act Rules 12b-20 (material information), 13a-1 (filing annual reports), 13a-11 (filing current reports), 13a-13 (filing quarterly reports), and 13a-15(a) (disclosure controls); and Rule 100(b) of Reg G (misleading NGFMs).  The SEC also charged  the CEO with violating Exchange Act Section 13(b)(5) (circumventing internal accounting controls); Exchange Act Rules 13a-14 (false certifications), 13b2-1 (falsifying books and records), and 13b2-2 (false statements to accountants); and Rule 100(b) of Reg G.  The SEC also charged that the CEO was a cause of Newell’s violations above.

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

Posted by Cydney Posner