An old saying states “Be careful what you wish for . . .” If that statement were recast into financial reporting it might go something like “Be careful what you define as a key measurement of financial success . . . and be consistent . . .” This is exactly the issue in one of the Commission’s most recent financial reporting cases, In the Matter of Heartland Payment Systems, LLC, Adm. Proc. File No 3-18819 (Sept. 21, 2018).
Heartland Payment Systems, founded by Robert Carr, also a Respondent, sells credit card processing services to retail merchants. An internal sales force conducts sales. Those sales persons are compensated with bonuses for newly signed merchants. They also receive residual payments based on actual merchant profitability on a monthly basis. The signing bonuses are based on a metric Heartland calls “new gross margin installed.” The firm defines this metric as “the expected annual gross profit from a merchant contract after deducting processing and servicing costs associated with that revenue.”
The aggregate of the new gross margin installed metrics paid to sales persons was referred to by the company and Mr. Carr as NMI. That metric was viewed as being a forward looking growth indicator because of its composition – new business and new sales. It was frequently cited in quarterly earnings calls by the firm for that reason. For example, NMI was cited in the earnings releases and/or calls for the third quarter of 2013, the fourth quarter of 2014 and the second quarter of 2015. Analysts such as Wells Fargo Securities cited the metric when discussing trends at the firm and others when assessing investment strategies.
Beginning in 2013 however, the firm altered the metric without disclosing that fact. First, in that year the firm included changes in ownership accounts which provided no net revenue growth. Indeed, Heartland and Mr. Car generally recognized that COOs as this information is called were not revenue generating new business. Yet these metrics became a material, but undisclosed, part of NMI.
Second, in March of 2013 the firm began adding margin from signing American Express and Discover card processing products to NMI numbers. While these numbers had previously been available for sales, and the revenue from the sale of them had been included in the firm’s net revenues, they had been excluded from sales person bonus calculations. Finally, the firm began including margin installed for three additional product types into NMI under a plan approved by Mr. Carr. These additions to NMI made it appear that the forward looking growth of the firm was materially accelerating at a more rapid rate that the original metric would have reflected. The order alleges violations of Securities Act sections 17(a)(2) and 17(a)(3).
To resolve the matter the firm consented to the entry of a cease and desist order based on Securities Act sections 17(a)(2) and 17(a)(3) while Mr. Car consented to a similar order based only on subsection 17(a)(2). The firm will pay a penalty of $2.16 million while Mr. Car will pay a penalty of $120,000. In determining to accept the offer of settlement the Commission considered the fact that Heartland merged with Global Payments in 2016 and that firm meaningfully cooperated with the staff during the investigation.