Will your rebate accounting come back to haunt you? Settle down around our campfire, and we’ll share some cautionary tales…
It’s a chilly October evening. You’re sitting alone in your kitchen, reading your favorite industry blog. Then, with a startling suddenness, your phone begins to ring.
You answer and a stranger’s voice says your name. Then, they tell you where they’re calling from. Your blood runs cold.
It’s not a masked killer, hiding inside your cupboard. It’s much worse.
It’s Martha calling from the Securities and Exchange Commission (SEC). She wants to talk about the profits your company posted in the last quarter. Specifically, she wants to know how you accounted for your rebates.
Horror stories like this one are all too common. And to celebrate Halloween, we’ve gathered together a few to chill the spine of distributors and vendors alike…
Heads roll at Target
Department store Target Australia was on track for $53m in earnings before interest and tax for the first half of FY2016—some $17m down on the same period in FY2015.
In an apparent attempt to address the shortfall, senior managers at Target decided to use rebate agreements to artificially boost its earnings. It arranged rebate programs with over 30 different suppliers for the first half of FY2016, promising that, in return, it would pay higher prices during the second half.
By March, Target’s parent group, Wesfarmers, had begun an investigation. By mid-April, three of target’s senior managers had quit, and Wesfarmers’ Managing Director had described their actions as “mind-blowingly stupid”.
Monsanto gets haunted by its ghostly rebate programs
A few months earlier, U.S. agribusiness Monsanto Company—best known for its flagship product, Roundup—had experienced its own rebate nightmare.
According to the SEC, “Monsanto’s sales force began telling U.S. retailers in 2009 that if they “maximized” their Roundup purchases in the fourth quarter they could participate in a new rebate program in 2010.”
The problem? If you use a rebate scheme to incentivize sales in one financial year, you need to record a proportion of the costs related to the program in the same year—unless you want to find yourself in breach of U.S. Generally Accepted Accounting Principles (GAAP).
Instead of recording the cost of this program in 2009, Monsanto delayed it until 2010, materially misstating its consolidated earnings in corporate filings.
In the words of Scott W. Friestad, Associate Director in the SEC’s Division of Enforcement, “Monsanto devised rebate programs that elevated form over substance.” These ‘ghost’ programs would ultimately lead to an $80 million penalty for violating accounting rules.
Tesco commits “market abuse”—and a regulatory nightmare ensues
In 2018, the UK’s Financial Conduct Authority said that Tesco plc and Tesco Stores Ltd had “committed market abuse” in relation to a trading update published in 2014.
The update stated an expected six-month trading profit for Tesco plc of £1.1bn. A matter of weeks later, the multinational retailer published a further update announcing it had “identified an overstatement of its expected profit”. According to the Financial Times, this overstatement was due to inflated estimates of rebate income owed.
When you combine the company’s agreed compensation package for investors with its plea deal with the Serious Fraud Office, the cost of Tesco’s mistake totals £214m.
The gruesome death of Dick Smith Holdings
Branches of Dick Smith Electronics were, until recently, a common sight on the streets of Australia and New Zealand.
But when Dick Smith Holdings (DSH) collapsed in 2016—leaving creditors more than $260m short—receivers Ferrier Hodgson made some shocking allegations. “By reason of DSH’s treatment of rebates,” their letter claimed, “DSH was able, in effect, to “borrow” profit from a subsequent year.”
Liquidator McGrathNicol subsequently found that the retailer's buying decisions were driven by supplier rebates rather than customer demand—sacrificing product mix for short-term profit.
A grim tale from the archives—Royal Ahold
At the turn of the millennium, U.S. Foodservice (now U.S. Foods) was already a major distributor of food to restaurants, hotels, schools and hospitals. When it was acquired by Dutch company Royal Ahold in 2000, its vendor rebate activities came under the purview of Ahold’s independent auditors Deloitte & Touche.
Initially, all seemed well. Then, in 2002, D&T discovered problems that caused them to not only suspend their current audit, but withdraw their audit opinions for the previous two years. For fiscal years 2000 through 2002, Ahold overstated net sales by approximately EUR 33 billion ($30 billion). For fiscal years 2000 and 2001 and the first three quarters of 2002, Ahold overstated operating income by approximately EUR 3.6 billion ($3.3 billion) and net income by approximately EUR 900 million ($829 million).
On February 24, 2003, Ahold announced it would restate earnings for FY2000, FY2001, and the first three-quarters of FY2002—reducing them by a total of over $500 million. Ahold's original SEC filings for at least fiscal years 2000 through 2002 were materially false and misleading.
That same day, the company’s stock price lost almost two-thirds of its value, and its Chief Executive and Chief Financial Officer resigned.
What had happened? According to testimonies from U.S. Foodservice insiders, its upper management had suggested bonuses were at risk unless sales increased in the last quarter of 2002.
The company’s chief operating officer had proposed a solution—order large amounts of inventory, immediately recognizing the vendor rebates. The strategy would not only pave the way for the company’s costly restatement of its earnings, but for a massive excess of inventory which, in some cases, had to be sold at a loss.
Bristol-Myers Squibb underpayments catch up with them
From 2007 to 2013, BMS allegedly underreported AMPs for multiple drugs by improperly reducing the reported AMPs for service fees paid to wholesalers. From 2014 to 2016, they also improperly excluded additional value received pursuant to price appreciation provisions in contracts with wholesalers, which also lowered the AMP amount. By taking those actions, BMS allegedly underpaid quarterly rebates owed to the states and caused the United States to be overcharged for its payments to the states for the Medicaid program.
Fraudulent claims get the better of Priority Healthcare
Priority Healthcare had to pay Roche Diagnostics $43.3 million to settle a lawsuit alleging that it fraudulently submitted claims to insurers and pharmacy benefit managers for Roche’s Accu-Chek blood glucose test strips that put Roche on the hook for tens of millions of dollars.
Roche claimed in its 2018 complaint that it had to pay more than $37.5 million in “unwarranted” rebates to insurance companies and PBMs for blood-glucose testing strips that either were different, pricier versions of the test strips patients actually received or were not shipped to patients at all. Roche also contended that Priority Healthcare’s efforts to introduce new pharmacies caused it to pay millions of dollars per year in unwarranted rebates for the tests.
Don’t have (rebate) nightmares…
As we’ve seen, inaccurate rebate accounting can lead to some very unwelcome consequences. And it isn’t always the result of a deliberate attempt to mislead the market.
Often, the sheer number and complexity of a company’s rebate agreements can cause it to stray from the safe, bright path of financial compliance, into the shadowy woods where GAAP is contravened, profits misstated, and dire prices paid.
That’s one reason why robust rebate management solutions, like Enable, are so vital. They help provide a single, auditable source of truth for rebate agreements—so you can protect your business against rebate accounting nightmares, and sleep a little easier.