SEC, Issuer, CFO Settle Financial Fraud Claims
A Luxembourg based seller of semiconductor products with the bulk of its operations in South Korea and a finance executive settled financial fraud charges with the Commission. Previously, the issuer restated its financial statements based on the findings of an internal investigation. The company and the former CFO agreed the entry of cease and desist orders based on fraud and other charges and to pay penalties, although the SEC acknowledged the firm’s remedial acts and cooperation. In the Matter of MagaChip Semiconductor Corporation, Adm. Proc. File No. 3-17956 (May 1, 2017).
MagaChip manufactures and sells semiconductor products. Its shares have been listed on the NYSE since its IPO in March 2011. Respondent Margaret Hye-Ryoung Sakai, a CPA, was a senior vice president, finance at the firm.
Following the firm’s IPO senior executives in Korea placed “immense pressure” on employees to meet the revenue and gross margin targets of the firm. Although employees objected, management refused to alter the targets. A series of improper accounting practices followed.
First, the company engaged in what was known as “pull-in” sales. MagaChip had direct sales through its sales force; others were made through distributors. Under the firm’s revenue recognition policy revenue was recognized on a “sell-in” basis. Specifically, when the company sold and shipped product to a distributer revenue was recognized. This policy was consistent with GAAP if there was persuasive evidence of an arrangement, the product had been delivered, the risk of loss transferred, the price was fixed and determinable and collection reasonably assured. MagnaChip sought to ensure compliance with these criteria by requiring the CFO to approve new significant sales contracts and changes to existing payment terms.
Nevertheless, the firm did not comply with its disclosed policy. From late 2011 through the third quarter of 2013 certain employees engaged in “pull – in” sales. Under this practice distributors were given undisclosed concessions through side agreements to incentivize them to order products earlier than necessary. A variety of concessions were used including granting an unlimited right of return, price protection, credit limit increases and others. Recognition of the revenue from these arrangements was thus contrary to GAAP. Although this practice was known to numerous individuals throughout the firm, the agreements were approved by Respondent Sakai.
Second, MagaChip also improperly recognized revenue on what were called “sun ip go” sales, a Korean term. This practice involved the recognition of revenue on sales of non-existent or unfinished product to meet targets. Following a meeting of certain employees in 2011 records were falsified to make it appear that product which had not been manufactured or which was still in production had been completed, shipped and billed to customers.
Third, the firm used a variety of other techniques that resulted in the improper revenue recognition. These included improperly accelerating the recognition of $1.8 million of revenue into 2011 by altering a purchase order; the recognition of revenue from turnkey sales on a gross rather than a net basis as required by GAAP where a portion of the product had been obtained from a vendor and MagaChip merely conducted certain processing; and failing to record expenses or revenue reductions in the appropriate period.
Fourth, the firm attempted to conceal rising accounts receivable. Firm policies required that customer payments be recorded against customer receivables in the proper period. The firm’s revenue practices resulted in increases to the amount of its receivables that were not paid in a timely manner. To conceal this fact employees applied payments on more recent sales to older ones. The firm also engaged in a series of improper transactions to make it appear as if the company collected about $16 million of uncollected receivables when it fact it had not.
Finally, MagnaChip at times engaged in efforts to manipulate its gross margins. In one instance, for example, the firm delayed scrapping certain inventory to avoid the resulting expense charge. The effect of this and other items was to inflate revenue.
As a result of these improper practices MagnaChip’s financial statements were materially false and misleading every quarter for almost two years. Throughout the period the company failed to maintain an effective control environment and its monitoring activities that should have detected errors were not effective.
In late 2013 the firm’s outside auditors and members of its board and audit committee independently raised concerns about MagnaChip’s rising accounts receivable balances. An internal investigation followed which revealed the practices used to falsify the financial statements. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5).
To resolve the proceeding the firm agreed to implement a series of undertakings. Each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, except the order as to the firm did not include Exchange Act Section 13(b)(5). The firm will also pay a penalty of $3 million. A larger penalty was not imposed based on cooperation. A failure to continue to cooperate, comply with its undertakings or if the Division obtains information indicating that the firm knowingly provide materially false or misleading information may result in the imposition of an additional penalty of up to $3 million. Respondent Sakai will pay a penalty of $135,000. She is also denied the privilege of appearing and practicing before the Commission as an account and barred from serving as an officer or director of a public company.