Recidivist Firm Pays $5.5 Million To Settle SEC Financial Fraud Claims
Financial fraud actions have long been a staple of the SEC’s Enforcement Division. In recent years, however, the number of those cases has been declining. Many of actions traditionally followed from restatements of the financial statements caused by material errors. The decline in the number of the cases seems to roughly track the downward trend in the number of issuers restating their financial statements. Since the number of restatements declined following the passage of the Sarbanes-Oxely Act, many argue that the statute is proving effective . While that may well be correct, the Commission continues to bring cases in the areas. Its latest example is not only based on a top down financial fraud, but involves an issuer that is a recidivist. In the Matter of Marvell Technology Group, Inc., Adm. Proc. File No. 3-19454 (Sept. 16, 2019).
Marvell is a producer of semiconductor components used in items such as data storage/hard drives, mobile phones and network devices. The firm operated through two divisions, Data and Storage. Previously Marvell settled an enforcement action with the Commission which alleged violations of the antifraud, internal control and books and records provisions based on the backdating of stock options. SEC v. Marvel Technology Group, Ltd., Civil Action No. CV-082367 (N.D. Cal Filed May 8, 2008).
By fiscal 2016 the firm had decided to reverse its traditional process for setting sales targets. The company had long built the models from the bottom up. After missing guidance for a period, the company initiated a top down process which imposed sales quotas. The sales staff believed that the targets generated by this process were not realistic. There was significant pressure to meet them. Turmoil resulted.
The new process did not spawn the desired results. At the same time sales were declining. The result was a top-down “pull-in” scheme implemented by senior management which assistance from the firm’s Financial Planning and Analysis unit that tracked the gap between actual and forecast revenue.
Under the plan Marvell’s customers were incentivized to accept delivery of product at an earlier time than would have been required. Many customers were reluctant to participate in the plan. There was significant internal dissent. Nevertheless, the company offered customers rebates, discounts, free products and extended terms to participate in the scheme during the fourth quarter of fiscal 2015 and the first two quarters of the next year. Thus, for example, in the last quarter of fiscal 2015 after the sales manager expressed concern at his ability to meet the revenue target, the firm had about $24 million in pull-ins. When the financial results were announced for the period the company had revenues of $85 million. It missed the low-end revenue guidance of $880 million but beat its EPS guidance by one penny. The misleading results were recorded in a Form 10k filed with the Commission.
In the first quarter of fiscal 2015 the pressure to use pull-ins continued. By mid-April the Financial Planning unit raised an alarm at the growing gap between actual and forecasted revenue. The firm reduced guidance. That reduction permitted Marvell to hit the forecast target for revenue guidance of $710 to $740 million The revenue numbers included $64 million in pull-ins. The inflated numbers were recorded in a Form 10-K filing with the Commission. The program continued.
The next quarter was no different. Several weeks into the period Marvell’s senior management renewed the pressure on sales managers to continue with the scheme. Public guidance was set at $710–$740 million. The Financial Planning group estimated that declining demand plus the impact of the pull-ins left the firm about $100 million short of goal. Yet by the end of the period the company had pull-ins of about $77 million or 11% of total revenue for the quarter. Again, the results were included in Commission filings. As a result, investors were misled as were the firm’s auditors. The internal controls of the firm had failed to halt the program.
Ultimately the board of directors became aware of the program. An internal investigation was launched. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a).
To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order. Merrill will also pay a penalty of $5.5 million.