SEC Resolves Financial Fraud Action
Financial fraud has long been a key SEC enforcement priority. The Commission’s most recent case in the area centered incorrect financial statements tied to the premature recognition of revenue reflecting errors and a failure to determine the correct accounting principles. In the Matter of Michael B. Hayford, Adm. Proc. File No. 3-18020 (June 9, 2017).
The proceeding centers on the premature recognition of revenue by UniTek Global Services, Inc., formerly a provider of infrastructure services to telecommunications, broadband cable, wireless, transportation and other industries. Specifically, the financial errors stem from the acquisition of Pinnacle Wireless, Inc. in early 2011 under an agreement that called for certain earn-out payments to the owners that would not exceed $30 million spread over 2011 and 2012. Respondents Michael Hayford, Kevin McClelland and Daniel Rothbaum are, respectively, the President and one of the founders of Pinnacle, UniTek’s Chief Accounting Officer and Corporate Controller, and Pinnacle’s Controller.
Pinnacle’s largest source of revenue was a contract to provide equipment and services for rebuilding portions of the World Trade Center with the Port Authority of New York and New Jersey. In 2011 Pinnacle provided internal forecasts estimating revenue for each quarter. The firm recognized revenue over long-term construction contracts incrementally as progress was achieved toward completion. GAAP permitted such recognition essentially under an approach based on either the incurred costs to date tied to estimated total costs after considering estimates of cost to complete based on the most recent data or as indicated by an alternative approach of progress toward completion that might be appropriate.
UniTek policy provided that revenue be recognized on a percentage of completion basis linked to costs incurred and invoiced upon completion of the job. The firm used a cost-to-cost method of measuring progress toward contract completion tied to costs incurred to date and the amount of costs expected to be incurred for the contract. Revenue was recorded as unbilled AR until invoiced.
Messrs. Rothbaum and McClelland reviewed the projected revenue under the contract and the forecast which suggested that Pinnacle would not meet its late 2011 revenue goals. The two men discussed whether the firm could recognize revenue based on the receipt of an invoice from a subcontractor who had agreed to provide custom equipment but had not yet performed under the contract. Neither had experience with percentage of completion accounting. UniTech CAO and Controller McClelland told his report, Respondent Rothbaum, that revenue could be recognized when the invoice was received if it matched the purchase order without conducting any research or consulting an expert in the area. Mr. McClelland did not further quality or define the test. Mr. Rothbaum did not ask for clarification. Mr. Hayford was then instructed to recognize revenue based upon receipt of the invoice.
Beginning in late 2011 UniTeck recording costs as incurred for percentage of completion purposes upon receipt of invoices. Messrs. Hayfor, Rothbaum and others at Pinnacle solicited invoices from six different subcontractors who were in the process of building equipment or providing services for the World Trade Center contract. This increased the revenue and profit. It also caused information regarding the Engineering and Construction segment of the firm, which represented a significant segment, to be materially incorrect in quarterly filings made with the Commission. For example, in the first quarter 2012 filings the segment revenues were overstated by 10.3% while its losses were under reported by 38.9%. In the second quarter of that year revenue was over reported by 4.6% while the quarterly losses were under reported by 224.9%.
During the period UniTek had a material weakness in its internal control over financial reporting. Specifically, the firm lacked sufficiently trained accounting personnel necessary to ensure that revenue was appropriately recognized. During the period Respondents were responsible for UniTek’s failure to maintain fair and accurate books and records. The Order alleges violations of Securities Act Section 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B).
To resolve the proceeding, each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition: Mr. Hayford will pay disgorgement of $35,000, prejudgment interest and a penalty of $125,000; Mr. McClelland will pay a penalty of $75,000; and Mr. Rothbaum will pay a penalty of $25,000. Messrs. McClelland and Rothbaum are also denied the privilege of appearing and practicing before the Commission as accountants with a right to apply for reinstatement after three years.