SEC charges UPS with failure to take goodwill impairment charge ...

Last week, the SEC announced settled charges against United Parcel Service Inc. for failing to take an appropriate goodwill impairment charge for a poorly performing business unit, thus materially misrepresenting its earnings. As alleged by the SEC, instead of calculating the write-down based on the price UPS expected to receive to sell its Freight business unit—as required under GAAP—UPS relied on a valuation prepared by an outside consultant, but “without giving the consultant information necessary to conduct a fair valuation of the business.” According to the Associate Director of Enforcement, “[g]oodwill balances provide investors with valuable insight into whether companies are successfully operating the businesses they own….Therefore, it is essential for companies to prepare reliable fair value estimates and impair goodwill when required. UPS fell short of these obligations, repeatedly ignoring its own well-founded sale price estimates for Freight in favor of unreliable third-party valuations.”  UPS was charged with making material representations in its reporting, as well as violations of the book and records, internal accounting controls, and disclosure controls provisions of the Exchange Act and related rules. UPS agreed to adopt training requirements for certain officers, directors and employees, retain an independent compliance consultant and pay a $45 million civil penalty.

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Background.  As alleged in the Order, in 2019, UPS performed an analysis, working with its outside financial advisors, to determine whether to sell one of the company’s poorly performing business units, UPS Freight.  On its balance sheet, UPS carried the unit at $1.4 billion, but the analysis concluded that UPS was more likely to sell Freight for only about $350 million to $650 million; that amount would have required UPS to recognize an impairment of about $500 million of goodwill associated with Freight and record a material charge to income. Although UPS decided against selling Freight at that time, the SEC maintained that “its analysis of what Freight’s sale price was likely to be should have been considered in the company’s goodwill impairment testing under GAAP.” Why? Because, under GAAP, the “fair value” of an asset is “the price that would be received to sell that asset in an orderly transaction between market participants,” and the analysis of Freight conducted by UPS “reflected a range of likely sale prices that were well below the business’s carrying value.” In the SEC’s view, “UPS should have recorded an impairment loss with respect to Freight’s goodwill.”

However, the SEC alleged, instead of relying on its own analysis when performing its annual goodwill impairment testing in 2019, UPS engaged an external consultant, as it had in the past, “to support the carrying value UPS had assigned to Freight without giving the consultant the information it needed to fairly value the business.  For example, UPS did not inform the consultant that its internal analysis had concluded a prospective buyer would expect Freight to generate significantly less profit after it was sold because it would no longer benefit from synergies and other cost savings it was getting as part of UPS,” such as favorable cost-allocation arrangements and the saving of human resources, technology, financial, accounting, legal, and pension-related costs that Freight did not bear as a part of UPS.  In addition, the SEC alleged, UPS used internal forecasts for Freight with “aggressive assumptions about revenue and profit growth in future years” that a prospective buyer would discount. Further, the consultant’s selection of peer companies, which were subject to confirmation as suitable by UPS, were not necessarily comparable; for example, unlike UPS, they were not unionized, information that UPS did not share with the consultant. The SEC charged that “UPS knew or should have known…that the consultant’s conclusions in 2019 would not reflect Freight’s fair value because the consultant’s assumptions, which UPS provided or approved, differed substantially from those market participants would use to value the business.”  Based on that information, the consultant valued Freight at about $2 billion, a valuation that the SEC contended was not a fair value estimate under GAAP, but a valuation that allowed UPS to avoid taking an impairment charge.   

As described in the Order, in June 2020, UPS began pursuing a sale of Freight, with the expectation that its “sale price was unlikely to exceed $650 million.”  In October 2020, UPS executed a non-binding term sheet to sell Freight for $800 million, a price that was “subject to various adjustments that were likely to reduce the final price.” The SEC alleged that management advised the board of directors that the company expected to “write off about $500 million in goodwill for Freight at the close of the transaction”; still, in its Q3 2020 goodwill impairment testing, the SEC charged that UPS valued Freight without taking into account the term sheet for the proposed sale.  Rather, UPS again relied on the consultant’s valuation of $2 billion, but did not advise the consultant of the terms of the proposed sale transaction. The SEC noted that, inconsistent with GAAP,  the “senior accountant supervising the impairment analysis wrongly concluded Freight’s goodwill would not be impaired until the period in which the company completed a sale of Freight.” The transaction was announced in January 2021, at a headline price of $800 million, with adjustments expected to reduce the price to $650 million. The announcement also advised that UPS would record a $500 million impairment charge.

The SEC charged that, in 2019 and 2020, UPS made materially misleading disclosures regarding its earnings, goodwill and shareholders’ equity in its Forms 8-K, 10-Q and 10-K, as well as during earnings calls, that were premised on its determination that no goodwill impairment charge was required for the Freight business unit—notwithstanding all the information that pointed otherwise.  Had UPS taken an impairment charge that was calculated in accordance with GAAP, the SEC claimed, its “reported earnings, goodwill balances, and shareowners’ equity would have been materially lower.” What’s more, UPS failed to disclose to its investors that “these reported items were materially dependent on valuations for Freight that did not reflect the business’s fair value and did not fairly align with information in the company’s possession about the assumptions market participants would use in valuing Freight.”  Rather, the SEC alleged, in periodic reports, UPS disclosed that the estimates used in its financial statements were based on the “most current and best information” available to the company, that its estimates “contemplate current and expected future conditions,” and that “its impairment tests indicated goodwill was not impaired.”  According to the Order, representations by UPS in its MD&A about its goodwill impairment were also false and misleading: for example, the SEC charged that, in the midst of negotiations in Q3 of 2020 to sell Freight at a price that was hundreds of millions of dollars below the value of Freight carried on the balance sheet, the company “falsely 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.” According to the SEC, UPS knew or should have known that these statements were materially false and misleading.

As alleged, UPS apparently made a number of invalid assumptions. For example, the SEC claimed that a then-senior UPS accountant did not consider the internal assessments of price range or the nonbinding sales agreement to be “relevant to the fair value determination.  Instead, UPS assumed that, until it executed a binding agreement of sale, the ‘best evidence’ of Freight’s fair value was the valuation consultant’s estimates.” In addition, “UPS assumed, for purposes of its goodwill impairment testing, that a potential buyer of Freight would be a firm equal to UPS in scale and would integrate Freight into its consolidated operations as UPS had.” (That is, the cost savings would continue.) However, the SEC asserted, “there was no factual basis for this assumption,” as UPS had concluded that none of the potential buyers were near the size of UPS. As experienced accountants at UPS knew, GAAP “requires that fair value estimates be based on ‘current market conditions’ rather than hypothetical scenarios under which a buyer is assumed to have the same characteristics as the seller.”

UPS did not recognize a goodwill impairment charge for Freight until the fourth quarter of 2020, after it agreed to sell Freight for a net price of about $650 million.  As a result of the charge, UPS’s fiscal year 2020 income from continuing operations was reduced by about 6%, net income by about 20%, goodwill balances by about 13%, and its shareholders’ equity by about 32%.

The SEC claimed that this misconduct “materially misled investors” and that UPS “failed to comply with its reporting, books and records, internal accounting controls, internal control over financial reporting, and disclosure controls and procedures obligations.” More specifically, the SEC charged that UPS’s failure to take the goodwill impairment charge as required under GAAP was partially the result of inadequate internal accounting controls and internal control over financial reporting:  “UPS failed to devise and maintain controls and procedures sufficient to provide reasonable assurances that its accountants were appropriately considering reliable indicia of Freight’s fair value, including the company’s internal assessments of Freight’s likely sale price range and, in 2020, information regarding the negotiations to sell Freight for considerably below its carrying value.”  In addition, the SEC charged that inadequate disclosure controls and procedures led to UPS’s disclosure failures in reports filed with the SEC.  

Violations. The SEC charged that UPS violated Section 17(a)(2) and (3) of the Securities Act (untrue statements or misleading omissions), Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, 13a-13 and 12b-20 thereunder (periodic reports), Exchange Act Section 13(b)(2)(A) (books and records), Exchange Act Section 13(b)(2)(B) (internal accounting controls) and Exchange Act Rule 13a-15 (disclosure controls and internal control over financial reporting.) Along with agreeing to remedial compliance training for certain officers, directors and employees and retention of an independent compliance consultant, UPS agreed to pay a civil penalty of $45 million.

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