This article initially appeared on The FCPA Blog, here and is reposted with the permission from the editor and publisher.
Alere Inc. paid more than $13 million last week to settle SEC charges of accounting fraud and overseas bribery. Embedded in the details are some very meaningful lessons for compliance leaders, and even more importantly, for business leaders. Those real-world lessons are about the accounting fraud.
The SEC’s release said Alere “improperly inflated revenues by prematurely recording sales for products that were still being stored at warehouses or otherwise not yet delivered to the customers,” adding that Alere also “engaged in improper revenue recognition practices at several other subsidiaries.”
That type of accounting fraud goes by many other names, but the one I have heard the most is “channel stuffing.”
I am quite familiar with this accounting maneuver, and proffered to the SEC about it in 2007. It often starts when quarter-end time approaches, where forecasts are short of plan, and the call to make your numbers leads to all sorts of solutions, of which channel stuffing is an oft deployed response.
Most of the time channel stuffing involves the transfer of title, and hence the recognition of revenue, where title has been financially (or legally) transferred but the goods themselves haven’t moved to the client.
In Alere’s case, as well in my own experience, goods were shipped to a warehouse, where the client was then invoiced but didn’t accept the product into their own facility (or drop-ship onwards). Hence, title and ownership weren’t actually transferred.
Sometimes the client does receive the goods along with the invoice, but it’s more product than they can reasonably use. So everyone knows that at some time in the future, those goods will be returned to the manufacturer or other seller. But the revenue is recognized now, with the hope that when it comes time to return the overage, better financial times will have arrived and the credit can be easily buried.
In my own career, invoiced goods (they were explosives) once sat at a freight forwarder for so long that the warehouse manager said we either needed to get them to the client or they had to be shipped back. There was going to be an inspection by a fire marshall and those goods had to be out of warehouse.
Regardless of whether widgets sit at a freight forwarder or in a distributor’s warehouse, pulling off the channel stuffing fraud “takes a village.” That village usually incorporates front-line commercial teams and financial executives, who often have a fiscal incentive to make their quarter. Other people typically involved include folks in sales order processing, accounts receivable, and logistics.
That leads to the question: Do your support teams, like those on the warehouse floor, sales order processing, and finance, feel like they are integrity and compliance ambassadors when they see paperwork and orders that are clearly out of the norm?
Or, do they see themselves as a small voiceless cog in a larger organizational process?
And how do they see their role when suspicious paperwork comes from their supervisors? Are they empowered to hit the pause button and start asking questions?
Those are great questions. But those questions aren’t what prompted this blog post. And you still might be wondering what does channel stuffing have to do with international anti-bribery laws?
Well, everything. If your commercial teams and those support functions know corners can be cut to meet commercial objectives, that sends out a very clear message to the entire organization: “Achieve your objectives above all else.”
I don’t know the specifics of the Alere case other than what I have read. But to find foreign bribery violations intermixed with accounting offenses comes as no surprise. Executives and business leaders who might think that cutting accounting corners doesn’t have an impact on how teams view their anti-bribery compliance program are ill-advised and proceeding at their own (great) peril.
The next time you don’t write down bad debt or obsolete inventory, or ship a product that you know is coming back at a later time, you might as well be saying, “Pay a bribe if you need to.” And no intranet splash screen or wall poster is going to overwhelm that very loud, yet unspoken, message.