Don’t Get “Pulled-In”: Marvell Fined by SEC for Failing to Disclose Aggressive Sales Plan
The SEC recently entered into a settlement with Marvell Technology Group, Ltd., based on Marvell’s manipulation of revenue reported in the company’s public statements. Marvell used so-called “pull-ins” — in which the company pulled revenue from future quarters into the current quarter — to mislead investors about the company’s ability to meet its revenue targets. The SEC’s resolution with Marvell — in which Marvell agreed to pay $5.5 million but did not admit or deny liability — is a potentially important development in the regulator’s approach because it is one of the first times the SEC has brought charges against a company which actually achieved its revenue goals, based entirely on the way that it achieved those goals. This case serves as a cautionary signal about the SEC’s evolving and more aggressive view about how companies achieve their revenue targets.
In late 2014, after missing revenue projections for two quarters in a row, Marvell executives imposed new sales targets, but could not bridge the gap between actual sales and revenue guidance. According to the SEC order, senior management instituted a “pull-in plan,” pressuring sales staff to meet targets by convincing customers to move future orders into the current quarter. In essence, Marvell knew that it would not meet its forecasted revenue projections, so it gave steep incentives to customers to buy products in the instant quarter rather than wait to purchase in future quarters. Among other things, Marvell obtained pull-in sales by offering price rebates, discounted prices, free products, and extended payment terms. Yet, even with these incentives, Marvell’s customers were often reluctant to agree to pull-in sales. As one Marvell employee remarked in reporting on a successful pull-in, Marvell had to “beg” the customer to agree to a multi-million dollar pull-in in exchange for discounts. In Marvell’s Q4 FY2015, which ended January 31, 2015, Marvell pulled-in $24 million of sales originally scheduled for future quarters. The practice continued to accelerate, with Marvell cannibalizing sales from future quarters to make the numbers or get close to projections in a current quarter.
The theory of the SEC case was that Marvell was misleading investors. First, Marvell said in its public statements that its financial results were “overall on target” when, in fact, senior executives knew that they were only achieving the results by giving incentives to customers, and that the revenue in future quarters would suffer as a result. Second, by masking the way the results in the instant quarter were achieved, the company was depriving investors of the ability to see the weaknesses in Marvell’s overall business. Marvell knew that many of its competitors were not having similar problems.
The SEC noted that this practice was highly controversial within the company and that some employees even raised questions about whether there was a disclosure obligation. Yet senior executives, including the chief executive officer, shot down these warnings. In one instance, the sales team reported that declining market demand made it all but impossible for the company to meet its revenue targets. As one of the senior operations managers observed, approximately mid-way through the quarter: “based on the damage we had to create in Q4 in regards to pulls, we started Q1 in the hole with the cabinets left pretty bare . . . . We did not empty the cabinets the first month for Q1 of last year like we did this time.” When that same senior operations manager pressed for more pull-ins, a sales employee responded: “We have tried our best to pull in. I think it’s not realistic to expect such a huge increase of revenue after [a huge Q4] pull in . . . . And I strongly suggest not [to] keep pulling in like this. It’s too risky.”
Moreover, Marvell’s senior executives failed to inform either the disclosure committee or the Board about the practice of pull-ins. During April 2015, one employee cautioned certain members of senior management, including the president, the CFO, and the head of FP&A, that Marvell’s use of pull-ins could trigger disclosure obligations because they could be masking a downturn in the company’s financial results. According to the SEC, the employee cited prior SEC actions against public companies that had distorted their financial results through unusual sales practices. Rather than heed the employee’s warnings, Marvell’s senior management ignored the warnings and then misled the employee by falsely asserting that the pull-ins were not being used primarily or solely to meet revenue guidance. The employee was instructed to send an email to senior management indicating that there were no issues with the pull-ins. The employee did as requested.
The case is unusual because Marvell did not falsely report revenue; the revenue reported was actually earned. Instead, the case was built on the idea that, in giving incentives to customers to pull revenue forward, Marvell knew but failed to disclose overall weakness in its business, and that the failure to disclose these facts constituted deception on the marketplace. This is a fairly radical departure from previous cases and could raise interesting disclosure issues for companies about what and when they are required to disclose about the overall health of their business and the details of what had to be done to achieve sales in a particular quarter. This case certainly leaves a lot of unanswered questions about where the SEC will go with this theory in the future.
One of the takeaways is that companies need to be careful about general statements regarding the overall health of the business. Here, Marvell’s statement that it was “overall on target” gave the Commission an avenue to say that investors were affirmatively misled (as opposed to the omission of material facts). Also, the level of controversy within Marvell, and the failure by top officials, including the CEO, to raise that controversy with either the Board or disclosure committee created an aura to the facts that made the case more appealing to the SEC. Clearly, good corporate governance would countenance that the Board and disclosure committees should be made aware of any major revenue issues of this sort.
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This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.