Securities Regulation Daily President and controllers caused company to overstate earnings due to improper revenue recognition
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Monday, June 12, 2017

President and controllers caused company to overstate earnings due to improper revenue recognition

By Joseph Arshawsky, J.D.

The SEC settled civil charges against Michael B. Hayford, President, and Kevin D. McClelland, CPA, and Daniel L. Rothbaum, CPA, Controllers of UniTek Global Services, Inc. (UniTek) and Pinnacle Wireless, Inc. (Pinnacle) for various violations of the antifraud, internal accounting controls, books-and-records, and reporting provisions of the federal securities laws. In addition to cease and desist orders, Hayford was ordered to pay $35,000 in disgorgement and a $125,000 civil penalty; McClelland was ordered to pay a $75,000 civil penalty; and Rothbaum was ordered to pay a $25,000 civil penalty. In addition, McClelland and Rothbaum were barred from SEC practice for three years (In the Matter of Michael B. Hayford, Kevin D. McClelland, CPA, and Daniel L. Rothbaum, CPA, Release No. 10369, June 9, 2017).

UniTek was until August 2014 a NASDAQ-listed company that provided infrastructure services to telecommunications, broadband cable, wireless, transportation, and other industries. In April 2011, UniTek purchased Pinnacle, a company whose largest source of revenue was a contract with the Port Authority of New York and New Jersey to provide equipment and services for rebuilding portions of the World Trade Center. Hayford was president of Pinnacle before the merger and division president of Pinnacle after the merger. McClelland was UniTek’s chief accounting officer and corporate controller. Rothbaum was Pinnacle’s controller and later Pinnacle’s accounting manager. All three were terminated in April 2013.

Percentage of completion. Between October 2011 and November 2012, the relevant period, UniTek materially overstated its earnings in its SEC filings by improperly recognizing revenue generated by Pinnacle. UniTek’s financial statements prematurely recognized revenue based on goods and services purchased from subcontractors using the percentage of completion (POC) accounting model. UniTek also lacked sufficient internal controls regarding proper revenue recognition for such goods and services. POC accounting is an accounting method for incrementally recognizing revenue in connection with long-term contracts as progress is achieved toward contract completion. UniTek measured progress using the cost-to-cost method, under which costs incurred to date for the contract are divided by the total amount of costs expected to be incurred upon completion of the contract. The percentage completion figure is then multiplied by the total project revenue to compute the amount of revenue that can be recognized as of that date.

Fraudulent activity. Hayford was responsible for setting and monitoring Pinnacle’s internal forecasts. He asked Rothbaum and McClelland whether costs and associated revenue could be recognized based upon the receipt of an invoice from a subcontractor under a long-term contract prior to the final delivery of goods or services. This would have the effect of allowing the company to recognize revenue earlier than it would have if it properly waited to do so until the goods and services were actually delivered. McClelland and Rothbaum were inexperienced in the POC method of accounting as applied to costs incurred for custom goods, and did not fully understand the relevant accounting principles with respect to this issue. Yet they failed to consult with outside experts, conduct research or seek training on the issue. As a result, they gave Hayford the wrong advice.

Hayford should have known, notwithstanding the bad advice, that it was improper to recognize revenue based on several of the invoices at issue because they contained inaccurate information about the value of goods delivered, payment terms, and quantity of work completed. In addition, all three individuals knew or should have known that UniTek lacked sufficient internal accounting controls over its process for recording and monitoring Pinnacle purchase orders. Based on the erroneous advice, Hayford and Rothbaum contacted subcontractors with whom UniTek had contracted to build custom ordered equipment or provide services, and requested that they send invoices prematurely, before all or in some cases any of the invoiced equipment or services had been delivered and without regard to the costs incurred by the subcontractors. As a result, UniTek prematurely recognized revenue and filed false and misleading financial statements.

Delayed disclosure. On April 12, 2013, UniTek filed a Form 8-K disclosing that several Pinnacle employees had engaged in "fraudulent activities that resulted in improper revenue recognition." Pinnacle requested invoices from six different subcontractors retained to provide goods and services, and prematurely recognized revenue. UniTek’s stock price dropped 50 percent on the news.

The release is No. 10369.

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