SEC Commissioner Caroline Crenshaw pointed to the enforcement action against The Kraft Heinz Company last week to illustrate why the agency’s approach to assessing penalties against wrongdoers is flawed.
In March, Crenshaw gave a speech to advocate a different way to determine financial penalties when companies commit fraud.
Historically, she said the market regulator has placed too much emphasis on factors beyond the violations when imposing penalties by looking at whether the company’s shareholders benefited from the misconduct or whether they will be harmed by a fine. (See Commissioner Crenshaw Criticizes SEC Approach to Imposing Penalties in the March 15, 2021, edition of Accounting & Compliance Alert.)
Some commissioners believed that any penalty that exceeds easily quantifiable benefits resulting directly from violations unfairly burdens the company’s shareholders. And she believes this approach is flawed because corporate benefits are difficult to quantify.
“If we limit penalties to only those benefits that are easy to count, we will invariably undercount, leaving the corporation in a potentially better economic position for having committed the violation,” Crenshaw said in a September 3, 2021, statement. “That is precisely the wrong outcome to advance our goals of punishing misconduct and delivering effective specific and general deterrents. Paying a penalty cannot be just a cost of doing business.”
Moreover, she said defendants strategically release bad news in ways that would mitigate or obscure the market’s adverse reaction. Thus, in her view, the resulting stock price change may not be an effective way to measure corporate benefits. And she said the enforcement action against Kraft highlights the problem.
On September 3, the commission said Kraft will pay $62 million to settle charges of accounting rule violations. The agency alleged the company ran a multi-year cost-management scheme. The SEC also charged Kraft’s former COO Eduardo Pelleissone and its former Chief Procurement Officer Klaus Hofmann for their misconduct related to the scheme. (See SEC Charges Kraft Heinz for Bogus Cost-Saving Scheme in the September 7, 2021, edition of ACA.)
In her statement, Crenshaw said Kraft first announced the SEC’s investigation to the public on February 21, 2019, at the same time it announced a dividend cut and a $15.4 billion goodwill write-down in certain reporting units and intangible assets.
The company also said that it recorded only a $25 million increase in cost of products sold related to its response to the commission’s investigation.
Further, Kraft said that it did not expect the matters under investigations to be “material to its current period or any prior period financial statements.”
Kraft’s stock price fell following the announcement.
“But Kraft’s release of all this negative information at the same time obfuscated what portion of the stock drop resulted from news related to its potential SEC violations versus the other significant issues,” Crenshaw said.
Then on May 6, 2019, she said Kraft announced that it planned to restate its financial statements for fiscal 2016, 2017, and the first three quarters of 2018 because it was nearing completion of an internal investigation into its procurement division.
The company’s press releases indicated that the misstatements were not “quantitatively material” and that “the findings from the investigation did not identify any misconduct by any member of the senior management team.”
A month later, Kraft filed an annual report that had the restated financial results, with the errors totaling $208 million, not $25 million. The report again said that the company did not identify any misconduct by any members of senior management.
“But I note we announced a settlement with a former Chief Operating Officer of Kraft for negligent misrepresentations and accounting violations,” Crenshaw said. “Corporate claims of lack of senior management involvement or materiality could also dampen the stock price reaction to negative news and affect a corporate benefit analysis.”
The commissioner said that the agency did not charge Kraft based on those statements, but they illustrate a practice that is far from unique.
Researchers use the term “information bundling” when companies release confounding news along with bad news. And a recent analysis showed that this practice results in fewer successful recoveries by private securities litigants who, unlike the SEC, must prove that corporate stock price losses were directly attributed to the specific bad news.
Researchers found that information bundling resulted on average in $21.17 to $23.45 million lower recoveries for shareholders.
“In considering the appropriate penalty to impose in actions brought by the SEC, I am concerned about corporate issuers benefitting from information bundling,” she said. “To the extent corporations thereby make it more difficult to measure corporate benefit, that merely reinforces my inclination in setting penalties to focus more heavily on other factors, such as punishing misconduct and effectively deterring future violations.”
This article originally appeared in the September 9, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.
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