Freight Accounting Fumble Leads to SEC Fine: UPS Penalized for Not Booking Known Impairment to Goodwill

The Securities and Exchange Commission (SEC) recently announced that United Parcel Service Inc. (UPS) has agreed to pay a $45 million penalty for materially misrepresenting its earnings by improperly valuing its UPS Freight business unit.  This settlement underscores the critical importance of disclosure controls, adhering to generally accepted accounting principles (GAAP), and the serious consequences of failing to record necessary – and known – impairments to goodwill.

The issue dates back to 2019, when UPS’s corporate strategy group analyzed whether UPS should sell its underperforming UPS Freight unit, which handled less-than-truckload shipments. UPS carried Freight on its books at a $1.4 billion carrying value, which included approximately $500 million in goodwill. As a part of that exercise, UPS concluded that Freight would likely sell for no more than approximately $650 million. According to GAAP, UPS was required to use this estimated sale price to assess whether it needed to write down the value of the goodwill assigned to the business unit on its balance sheet. However, instead of relying on this internal analysis, the UPS accounting team used a valuation from an outside consultant, which estimated Freight’s worth at about $2 billion—three times UPS’s own estimate. The consultant’s valuation was based on assumptions, approved by UPS, that were not reflective of what a prospective buyer would consider. Based on this valuation, UPS avoided taking an impairment, and thus avoided the attendant hit to income.

In 2020, UPS entered into a non-binding term sheet to sell Freight for a top-line price of $800 million, with adjustments likely to substantially reduce the final price. UPS did not share this term sheet with its valuation consultant, who again valued the Freight business at about $2 billion. UPS thus again avoided impairing the business’s goodwill for the first three quarters of 2020. Had UPS properly valued Freight in both 2019 and 2020, its earnings and other reported items would have been materially lower.

In the third quarter of 2022, in discussing the $800 million term sheet to sell Freight, UPS management informed the board that they expected to write off about $500 million in goodwill when the sale closed. This was inconsistent with GAAP, which requires the impairment to be booked when it is determined that the fair value has declined below the carrying value; GAAP does not allow such impairment to be postponed until the assets are sold. When UPS ultimately sold the Freight business for approximately $650 million and booked the $500 million impairment in the fourth quarter of 2020, the associated write-off reduced its net income by 20%.

In addition, in the third quarter of 2020, while UPS was in negotiations to sell Freight for hundreds of millions of dollars below its carrying value, the company claimed in a Form 10-Q that there had been “no events or changes in circumstances” that would indicate Freight’s goodwill may be impaired.

The SEC’s order found that UPS violated Sections 17(a)(2) and (3) of the Securities Act, so-called negligent securities fraud, as well as various provisions of the Exchange Act related to reporting, books and records, internal accounting controls, and disclosure controls. In addition to the $45 million civil penalty, UPS agreed to cease and desist from further violations, adopt training requirements for certain officers, directors, and employees, and retain an independent compliance consultant to review and make recommendations about the company’s fair value estimates and disclosure obligations.

This matter serves as a stark reminder for public companies about the importance of internal controls and disclosure controls in generating accurate and reliable financial reporting. Goodwill balances provide investors with critical insights into the operational success of a company’s business units. Companies must ensure that their fair value estimates are prepared reliably, shared with the appropriate parties to ensure accurate accounting and appropriate disclosures, and that goodwill impairments are recorded when necessary. Ignoring internal analyses in favor of unreliable third-party valuations can lead to significant regulatory penalties and damage to a company’s reputation.

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.