SEC Enforcement Action Highlights Importance of Internal Controls

The Commission’s action against PACCAR Inc, a commercial truck manufacturer, emphasizes the importance of good internal accounting controls. SEC v. PACCAR Inc., Civil Action No. 2;13-cv-00953 (W.D. Wash. Filed June 3, 2013). The case centers on three separate errors in the financial reporting of the company. Each traces to deficiencies in the internal accounting controls of the company.

The errors occurred in the period 2008 through the third quarter of 2012. During that period the Fortune 200 manufacturer and distributor of trucks and related aftermarket parts sold under the nameplates Kenworth, Peterbilt and DAF, reported two segments in its Commision filings. One was for trucks and aftermarket part sales and the other for financial services. Errors occurred in each segment.

Reportable segment: In its Form 10-K for the period ended December 31, 2009 PACCAR did not separately report income before taxes from truck sales and aftermarket part sales. GAAP, and the applicable Commission rules, require an issuer to report select information about reportable segments. A reportable segment is one which engages in business activities from which it may earn revenues and incur expenses, has operating results regularly reviewed by the chief operating decision maker and has discrete financial information available. The point is to permit investors to view the entity through the eyes of management.

Here PACCAR parts maintained separate internal financial statements which were regularly reviewed by its chief operating decision maker. Company executives viewed the business as a segment, a point reflected by internal strategic planning materials which divided the overall business into three segments — trucks, parts and financial services. By failing to include segment information in the Form 10-K, the company violated GAAP — investors could not see the results available to company executives. Those showed that the reported pre-tax income of $68 million resulted from the combination, before certain shares expenses, of a $474 million loss from the truck segment and a $542 million profit from the part sales.

Impaired receivables: PACCAR and its related finance company, defendant PACCAR Financial Corporation, understated impaired receivables and the associated specific reserve in the financial statement notes to the 2009 Form10-K, according to the complaint. In that filing the company failed to disclose that all of its non-accrual receivable as of year end were impaired. This resulted in a 24% understatement. It also failed to include all troubled debt restructurings in its impaired receivables disclosure. This resulted in a 39% understatement of impaired receivables. Likewise, the company failed to disclose the impairment of leases to its two largest past due customers, despite concerns of executives who were monitoring them. This resulted in a 64% understatement from what was actually reported for impaired receivables.

Retail loans and direct financing leases: The company overstated the amount of (a) retail loans and direct financing leases originated and (b) collections on retail loans and direct financing leases in its consolidated Statement of Cash Flows for the quarters ended June 30, 2009 and September 30, 2009. The amounts were equal and offsetting so there was no change to the amount of net cash provided by investing activities reported. The company identified these errors during the first quarter of 2010 and acknowledged them, along with the others, in comment letters in responses to the Commission staff.

While the complaint states that the errors resulted from inadequate internal controls and policies and procedures, it also acknowledges that the company has implemented remedial measures. It alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B).

The company resolved the action, consenting to the entry of a permanent injunction prohibiting future violations of the Sections cited in the complaint. It also agreed to pay a civil monetary penalty of $225,000. The settlement takes into account the remedial actions of the company.

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