Wednesday, October 1, 2008

Penn Traffic Settles with SEC Over Premature Recognition of Vendor Allowances

SEC Complaint: The Securities and Exchange Commission ("SEC") filed and settled a complaint against Penn Traffic grocery stores for improperly overstating revenues.

In a complaint filed on September 30, the SEC alleged that Penn Traffic prematurely recognized income from promotional allowances such as slotting fees, rebates, and other vendor allowances, resulting in significantly overstated earnings reports. From 2001 to 2003, Penn Traffic recorded revenue related to promotional allowances before it "earned" the revenue by performing the agreed upon merchandising programs.

The SEC also alleged a separate accounting scheme in which a Penn Traffic subsidiary, Penny Curtis, created fraudulent accounting entries and adjustments in order to meet sales targets set by Penn Traffic.

The SEC announced that Penn Traffic agreed to settle the charges by consenting to the entry of a permanent injunction against violations of certain securities laws, and to certain oversight by an independent examiner. The SEC's case against two executives involved in the alleged wrongdoing is ongoing.

Pressure to Boost Earnings: Penn Traffic filed for bankruptcy in 2003, and there was likely substantial pressure on businesspeople to meet financial targets during the 2001 to 2003 time frame at issue. Prematurely recognizing revenues for one quarter would create a deficit in the following quarter, creating additional pressure to use such unlawful accounting techniques for future quarters.

Similar to Penn Traffic, wholesalers and retailers – including Ahold, K-Mart, Nash Finch, and Fleming (before it filed for bankruptcy) – have faced SEC inquiries and class action lawsuits with respect to the accounting treatment of slotting fees, promotional allowances, and other vendor allowances.

Accounting of Trade Funds: Accounting treatment of trade funds/vendor allowances has evolved since the early 2000s for all industry stakeholders, including manufacturers, wholesalers, and retailers. The Emerging Issues Task Force ("EITF") of the Financial Accounting Standards Board has provided industry guidance as to how to account for trade funds/vendor allowances. Industry stakeholders should review the EITF's guidelines on the accounting of trade funds/vendor allowances, including, for example, EITF Abstract Issue No. 9 ("Accounting for Consideration Given by a Vendor to a Customer") and EITF Abstract Issue No. 02-16 ("Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor").

Related post: Channel-Stuffing Lawsuit Settled for $137.5 M.


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