Earnings Management Keyed to A Poor Control Environment
Earnings management has long been a key concern for the Commission and its Enforcement Division. While the agency has in recent years made various efforts to focus on the issue, few cases have resulted. Indeed, many of the accounting cases developed have followed a restatement of the firm’s financial statements.
This week, however, the agency filed a settled proceeding which centered on claims of earnings management tied to a poor control environment. The company and its CFO are named as respondents. In the Matter of Rollins, Inc., Adm. Proc. File No. 3-20824 (April 18, 2022).
Respondents are Rollins and its CFO, Paul Northen. The Atlanta based firm provides termite and other pest control services to residential and commercial companies through brands such as Orkin. Its shares are traded on the NYSE. Mr. Northen served as CFO for seven years beginning in 2015.
Rollins had developed a culture focused in part on earnings consistency. In the first quarter of 2016 the quarterly report filed with the Commission announced that the firm was posting its “40th consecutive quarter of improved revenues and earnings. . .” The earnings release for the second quarter of 2017 announced the “45th consecutive quarter of improved earnings and revenue.”
Each quarter the company made a determination as to the appropriate amount to reserve or accrue for several categories of lability accounts. Those included reserves for items such as a termite reserve which is an estimate of actual or potential damage claims by customers. The firm also had certain corporate-level reserve accounts. Those were determined after the reporting units results were available. The CFO had the final determinative authority over the amount of the corporate-level reserves.
In the second quarter of 2017 CFO Northen directed a reduction to certain corporate-level accounting reserves. The purpose was to enable the company to publicly report earnings per share in line with research analysts’ consensus estimates. Mr. Northen was aware at the time that the company earnings were close to but not at consensus estimates when directing that the adjustments be made. Without the adjustments for the first quarter of 2016 and the second quarter of 2017 the company would have been below the consensus by one cent.
At the time of the reserve adjustments Rollins’ accounting personnel had significant discretion. The firm also had an environment of inadequate internal controls. As a result, the company failed to devise and maintain sufficient internal accounting controls. The Order alleges violations of Securities Sections 17(a)(2) and 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) and 13(b)(5). The Commission considered the cooperation and remedial acts taken by Rollins.
To resolve the proceedings the company consented to the entry of a cease-and-desist order based on each of the Sections cited in the Order except Exchange Act Section 13(b)(5). The firm will also pay a civil penalty of $8 million. In addition, Mr. Northen resolved the proceedings, consenting to the entry of a cease-and-desist order based on each of the Sections cited in the Order. He agreed to pay a civil penalty in the amount of $100,000.