The Coca-Cola Co. agreed last week to make changes to its compliance procedures to settle charges by the Securities and Exchange Commission that the world’s largest soft drink maker engaged in “channel stuffing” to inflate its sales numbers for several years in the late 1990s.
The SEC alleged that, during a three-year period, Coke asked bottlers in Japan to purchase additional quantities of cola concentrate in order to boost the company’s revenues and help it meet profit goals.
“Coca-Cola misled investors by failing to disclose end of period practices that impacted the company’s likely future operating results,” said Richard Wessel, head of the SEC’s office in Atlanta, where Coca-Cola is based.
Bruce Carton, the vice president of Securities Class Actions Services for Institutional Shareholder Services in Rockville, Md., said that, on the surface, what Coke did here was “what almost all public companies do quarter-to-quarter—it’s par for the course for companies to do every single thing they can to make their number.”
Freeman
William Freeman, chairman of the securities litigation practice group at Cooley Godward, said that there are “seldom bright lines in this area.”
Freeman, of Palo Alto, Calif., said “it’s easy to see when an egregious case has been committed, when a company pushes excess product to customers and re-sellers that are well beyond their needs—and provides rebates and incentives for the customers and re-sellers to take it. But there are also plenty of grey areas.”
The Coke settlement "shows that the SEC is very concerned about channel stuffing," Freeman said. "It suggests that this is something the SEC is interested in pursuing. It also suggests to me that agreeing to establish a very thorough corporate compliance program can go a long way toward helping a company negotiate a better resolution with the SEC. In this case, Coke agreed to some extraordinary measures-the establishment of new positions in the company and the tightening of its disclosure procedures. Had they not done so, they might have been dealt with more harshly."
Kicking The Bottlers
In its enforcement order, the Commission said that, at or near the end of each reporting period between 1997 and 1999, Coke implemented an undisclosed channel stuffing practice for the purpose of pulling sales forward into a current period.
The SEC alleged that Coke’s Japanese bottlers were offered extended credit terms to induce them to purchase quantities the bottlers otherwise would not have purchased until a following period. As a result of the channel stuffing, the Japanese bottlers’ concentrate inventory levels increased at a rate more than five times greater than that of finished product sales to retailers.
This practice, said the SEC, pulled forward sales from subsequent periods and “contributed approximately $0.01 to $0.02 to Coca-Cola’s quarterly earnings per share and was the difference in 8 out of the 12 quarters from 1997 through 1999 between Coca-Cola meeting and missing analysts’ consensus or modified consensus earnings estimates.”
Despite the impact on the bottom line, “Coca-Cola failed to disclose its [channel stuffing] practice in its periodic reports,” the Commission said. “[The] failure to disclose the impact of [channel stuffing] on current and future earnings, as well as [certain] false statements and omissions within [a] Form 8-K [filed in January 2000], violated the antifraud and periodic reporting requirements of the federal securities laws.”
In announcing the settlement, which resulted in a cease-and-desist order but no fine, the Commission praised Coca-Cola’s willingness to change its ways. “Prior to and during the investigation, Coca-Cola took laudable and substantial steps to enhance and strengthen its disclosure review process to prevent similar failures from occurring in the future,” said Katherine Addleman, associate director of enforcement for the Commission’s Atlanta office.
‘Keep It Real’
The lesson from the Coke settlement may be for companies to “keep it real,” as the soft drink giant’s current slogan goes, when it comes to putting product into the marketplace.
“What the SEC appeared to be concerned about here was not the GAAP [Generally Accepted Accounting Principles] issues but how the company explained its position in its MD&A [Management's Discussion and Analysis],” said Freeman, of Cooley Godward. “The SEC appeared to reach the conclusion that, even if the accounting was correct, the way the company described its periodic results was misleading.”
If Coke “had explained that a particular period’s revenues were affected by bottlers taking excess supplies, that could have solved the problem,” Freeman said. “MD&A requires issuers to explain or to disclose reasons that a particular period’s results might not be typical, why there might be variation in the future.”
Henning
Peter Henning, a professor at Wayne State University Law School in Detroit, told Compliance Week that channel stuffing is “more than just a disclosure issue.”
Coke was “caught in a trap that any number of companies have been caught up in. They had created high expectations for themselves and couldn’t risk lowering their expectations,” Henning said, noting that channel stuffing happens most often when companies are dealing with a decline in demand for their product.
Companies get in trouble when they “cross an invisible line,” Henning said. “You’re allowed to sell product and ship it in the hope it will be sold, but at some point you cross a line so that it’s no longer a defensible business decision.”
Here, Coke didn’t engage in “really blatant stuffing,” which is why a criminal investigation against the company wasn’t pursued, said Hennning, who noted that there may be many instances of channel stuffing that go undetected because “the channel ends up getting unblocked.”
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