SEC charges company and finance executives with raiding the cookie jar | Cooley LLP

Just in time for the holidays – cookie jars are full…revenue adjustments! In this complaint, the Securities and Exchange Commission (SEC) directed American Renal Associates Holdings, Inc. , a national provider of dialysis services, and three of its financial managers charged with securities fraud and other misconduct. According to the Securities and Exchange Commission, the alleged fraudulent plan included “a series of revenue adjustments to show that ARA has outperformed, met, or came close to meeting several predetermined financial measures, when in fact its financial performance was materially worse.” After receiving an inquiry from the Securities and Exchange Commission, ARA conducted an internal investigation that prompted the company to restate its financial statements, which, according to the Securities and Exchange Commission, showed the company had overstated its net income for 2017 by more than 30% and by more than 200%. In the first three quarters of 2018. Revenue adjustments to the cookie jar, which the SEC charged, were a key ingredient used in this alleged effort to cook the company’s books.

ARA owns and operates dialysis clinics through joint ventures with physicians across the country, where physicians provide patient care and ARA handles billing, collection, revenue management, and patient insurance matters. Insurance reimbursement for dialysis treatments was a major component of ARA’s revenue. ARA traded on the New York Stock Exchange until it was acquired by the private equity firm in 2021. Key industry metrics were DSO, or days sales pending, and RPT, or revenue per transaction, as well as adjusted EBITDA-NCI (excluding non-controlling interests). According to the Securities and Exchange Commission, these metrics have been particularly important to investors and analysts, and ARA has been regularly touting its performance on these metrics, such as its consistently low DSO, to potential new doctors and in SEC filings and earnings calls.

As described in the complaint, the crux of the alleged fraud was the company’s methodology for estimating and using “upper side adjustments.” For companies that ARA has a contract with, ARA can simply book revenue at the pre-determined rate. However, in the absence of an agreed contract or price, ARA used a two-step process: First, ARA made a preliminary estimate of the revenue it would receive. Second, the ARA will perform a “revenue adjustment to correct the initial estimate of the amount already collected,” as required by the GAAP. These adjustments, which can be positive or negative, were called “upside adjustments”. Under the stated ARA methodology as described in the company’s internal accounting controls, upside adjustments are to be based on a detailed patient-level analysis that entails “comparing actual payments received for a particular patient’s course of treatment with prior estimates of what those payments would be.”

The Securities and Exchange Commission (SEC) claimed that after the departure of the former COO (who apparently followed a process for upside-down adjustments that no one seemed familiar with, but which is not the subject of the complaint) at the end of 2016, financial executives developed their own procedures. For revenue recognition and upside adjustments, which the SEC described as “more than a fraudulent scheme [to book] Millions of dollars in top-side adjustments that weren’t built on patient-level detail, but instead were booked to meet pre-set financial metrics….[The executives’] The decision to use this top-down approach, which is not based on any detail at the patient level, was highly unreasonable and represented a severe departure from normal standards of care.” This decision, the SEC accused, of using a “top-down approach” To reserve revenue [an executive] He wanted the ARA, rather than increasing revenue from actual patient-level data, to be the heart of the upside scheme.” Other alleged improper accounting practices that the Securities and Exchange Commission has identified to be part of the scheme are: “a) bank adjustments identified on the upside For use in future quarters, b) spreading upside adjustments across multiple months, including across different chapters, and c) finding and/or creating upside balancing adjustments between clinics in order to achieve a net zero impact on total revenue and DSO.”

In particular, the executives created a “contractual adjustments” spreadsheet, which the Securities and Exchange Commission claimed served as a “cookie jar” that ARA used “to find higher revenue when needed. (See this PubCo post and this PubCo post for details). Discussions about other cases involving packets of cookies.) As of July 2018, ARA had identified $35.7 million in net service-related overcollections made in the second quarter of 2018 or earlier, but had only recorded $29.6 million previously. End of the second quarter of 2018. The remaining $6.1 million, comprising $10.2 million in unreserved excess collections and $4.1 million in unreserved excess collections, has been carried over to future quarters via the contractual adjustments spreadsheet in A cookie jar.” As the SEC alleged, an incorrect top-side process was used to target DSOs, as well as to achieve the specific goal of standardized RPT. To that end, the Securities and Exchange Commission accused one of the executives of directing another person to “find” sufficient revenue in topside adjustments to achieve a measure of RPT in ARA’s budget, about $3 million in topside adjustments. The Securities and Exchange Commission cited support from internal emails that implemented those instructions and an employee (later fired) questioning the appropriateness of the procedure. The Securities and Exchange Commission also alleged that the executives failed to disclose the top-side adjustment practices of the company’s audit firm, created fake documents to support their adjustment methodology, and signed bogus affidavits.

The level of net topside adjustment continued to increase significantly during the first three quarters of 2018, accounting for 92% of reported net income and 280% of restated net income, when the SEC inquiry led to an internal investigation and a reformulation Financial “significant changes appear in nearly every financial measure”. According to the complaint, the re-statement admitted that the company did not comply with generally accepted accounting principles and had material weaknesses in its internal controls. The share price fell.

According to the complaint, financial executives received inflated cash bonuses and bonuses based on financial statements that incorrectly reflected the achievement of performance measures. (As a result of the restatement, the company’s former CEO, who has not been indicted, returned nearly $900,000 in compensation.)

The Securities and Exchange Commission complaint 16 brings a claim against the defendants, including violations of the anti-fraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the SEC; Section 13(a) and Rules 12b-20, 13a-1, 13a-11, and 13a-13 for reporting violations; Section 13(b)(2)(a) if accurate records and books are not kept; Rule 13b2-1 for falsification of books and records; and Exchange Act sections 13(b)(2)(b) and 13(b)(5) for failure to maintain adequate internal accounting controls and willfully evasive. Most of these claims also included separate claims for aiding and abetting against some or all of the finance executives. The complaint also accuses some or all financial executives of making false statements to auditors, including signing false management representation letters, in violation of Rule 13b2-2(a) and signing false affidavits in violation of Rule 13a-14. There were also charges under the refund provisions in SOX 304(a), as a result of a return of the statement for misconduct.

ARA agreed to settle by agreeing to a permanent injunction and a civil fine of $2 million, all subject to court approval. The Securities and Exchange Commission (SEC) is seeking a permanent injunction, removal of pretrial, civil penalties, and compensation under SOX 304(a) and warrants for officers and directors against CFOs.

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