Mattel, Thomas the Tank Engine and Financial Misstatements
There are probably few Commission actions centered on financial misstatements tied at least in part to a toy. There may be even fewer financial misstatement cases where the company announced a restatement tied in part to a toy. Yet this is precisely the situation in which Mattel Inc. found itself. In the Mater of Mattel, Inc., Adm. Proc. File No. 4355 (October 21, 2022).
Mattel is a California based toy maker. The firm’s shares are listed on NASDAQ under the symbol MAT. The Order in the action centers in part on Thomas the Tank Engine, a toy marketed and sold by Mattel.
In August 2019 the company received a whistleblower letter. It stated that the firm’s financial statements may have material errors. The letter also claimed that the engagement partner for the audits conducted on the firm’s financial statements may not be independent.
The company took action. First, a then on-going offering of notes was halted. Second, the Audit Committee launched an investigation. Investigators determined that there were in fact errors in the company financial statements.
Specifically, the investigators discovered that the tax-related valuation allowance for Q3 2017 was understated by $109 million. They also found that the tax expense for Q4 2017 was overstated by $109 million. The valuation understatement in Q3 resulted from Mattel’s Thomas the Tank Engine being classified as a definite lived asset that should be amortized. That conclusion was wrong. At the time the toy was classified as indefinite lived.
In October 2019 Mattel announced that it would restate the financial results for Q3 and Q 4, 2017. While the under and over statements in Q3 and Q 4 were each $109 million, there were additional issues. Mattel’s Q3 2017 provision for income taxes was understated by 14% and net loss and net loss per share were understated for income taxes by 15%. Likewise, for Q4 2017 the firm’s provision for income taxes was overstated by 62% and net loss and net loss per share were overstated by 63%. The engagement partner also violated the auditor independence rules. A restatement was conducted in 2019.
The errors resulted from two material weaknesses in internal control with regard to financial reporting. One resulted from a failure to design and operate an internal control over the review of the income tax valuation allowance analysis. That was remediated by the end of December 2018.
The other weakness resulted from a failure to design and operate internal controls to properly assess and communicate known financial statement errors and internal control deficiencies in a timely manner to those correcting the error. In the end, the outside auditors also restated their report on internal control over financial reporting, issuing an adverse opinion. A restatement of the financial statements for the periods was made in November 2019.
The Order alleges violations of Securities Act Sections 17(a)(2) & (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The company cooperated with the Commission’s investigation. The CFO also left the firm. Mattel resolved the proceedings, consenting to the entry of a cease-and-desist order based on the Sections cited in the Order. The company also agreed to pay a penalty of $1.5 million. See also In the Matter of Joshua Abrahams, CPA, Adm. Proc. File No. 321214 (October 21, 2022)(proceeding naming engagement partner as Respondent alleging violations of Rule 102(e)(1)(iv)(B); the matter will be set for hearing).