Cannabis Company Settles Charges for Making Material Accounting Errors in Financial Statements
Commentary by Ilan T. Graff
A Canadian cannabis company settled SEC charges for filing financial statements with the SEC containing material accounting errors, and failing to maintain adequate internal accounting controls. The former CFO and CCO of the company also settled charges for failing to disclose the terms of an oral agreement that resulted in the company overreporting revenue. The company and its former CFO neither admitted nor denied the SEC's findings in connection with the settlement.
In the Order, the SEC found that the company made material accounting errors in its quarterly reports in the first and third fiscal quarters of 2019, and the second fiscal quarter of 2021. In the two 2019 quarters, the company failed to analyze whether to report revenue from a bulk sale to a third party when the company simultaneously engaged in a bulk purchase from the same third party and improperly recognized the revenue from the sale.
Additionally, the SEC found that the agreement in place between the company and the third party did not contain commercial substance as required by International Financial Reporting Standards. In a separate transaction in the third quarter of 2019, with a different counterparty, the company agreed to sell product to the counterparty and repurchase it in the following fiscal quarter, but the company improperly recognized the revenue at the time of sale.
In addition, the SEC found that during the second quarter of 2021, the company failed to perform a GAAP-compliant interim impairment test, because its U.S. business did not perform relative to its expectations. The SEC determined that the company's internal accounting controls were insufficient to guarantee that a test had been conducted.
Although the company reissued its financial statements and identified the weaknesses in its accounting controls, the SEC determined that the company violated Securities Act Section 17(a) ("Fraudulent Interstate Transactions"), Exchange Act Section 10(b) ("Regulation of the Use of Manipulative and Deceptive Devices"), Section 13(a) and Section 13(b)(2)(A)-(B) ("Periodical and Other Reports").
The SEC also found that the company violated SEA Rule 10b-5(a) and 10b-5(c) ("Employment of Manipulative and Deceptive Devices"), Rule 12b-20 ("Registration and Reporting - Additional Requirements"), Rule 13a-13 ("Quarterly Reports on Form 10-Q"), Rule 13a-15(a) ("Controls and Procedures"), and Rule 13a-16 ("Reports of Foreign Private Issuers on Form 6-K").
To settle the charges, the company agreed to (i) cease and desist from future violations of the charged provisions and (ii) retain an independent compliance monitor to make recommendations for improved financial reporting practices. In light of the company's self-reporting and cooperation with the investigation, the SEC did not deem a financial penalty necessary.
Commentary
The SEC's Enforcement Director has spoken at length about "affirmative behavior" as a pre-requisite for cooperation credit, highlighting, among other things, self-reporting, remediation and advocacy that "meaningfully illuminate[s] events." The absence of a fine as part of this resolution, despite the SEC's determination that the company had repeatedly engaged in improper accounting, strikingly illustrates the staff's commitment to incentivizing timely and robust cooperation.