IT Value

NEC, Hit by Revenue-accounting Woes, Settles with SEC

Japanese electronics giant, with fraud troubles too, agrees to having its U.S. securities registration revoked.
Stephen TaubJune 18, 2008

NEC Corp., the Japanese electronics giant mired in revenue-recognition accounting problems and wracked by fraud, agreed to a Securities and Exchange Commission revocation of NEC’s securities registration in the U.S.

In the SEC’s settlement with NEC, which did not admit to or deny the SEC’s findings, the company also said it would cease and desist from committing or causing any violations and from any future violations of certain securities rules.

The SEC said it took the action after NEC failed to file annual reports with the commission for fiscal years 2006 and 2007. Further, the SEC found that for fiscal years 2000 through 2005, the annual reports that NEC did file misstated revenues and net income or net loss results — in part related to improperly recognized revenues from 2000 through 2006, which reflected contracts with customers that included provision for hardware, software, and customer support. NEC also failed to maintain accurate books and records, and had deficient internal accounting controls, according to the regulator.

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NEC, which had its American Depositary Receipts delisted from the Nasdaq Stock Market in October 2007, said a statement that no surcharge or other forms of monetary payment was required under the SEC’s order.

NEC is far from the only technology company to be stumped by revenue recognition rules, which under U.S. generally accepted accounting principles are extremely complex, especially when involving contracts that blend the sale of software with maintenance and service agreements. In one example of the difficulties faced, GAAP standard SOP 97-2 calls for companies wanting to recognize software-sales revenue up-front to performan an analysis of the contracrts that offer “vendor-specific objective evidence,” or VSOE, showing consistent accounting treatment of sales and service.

In 2006, NEC restated its earnings three times, according to an earlier Reuters report. The first revision had been required after the company discovered that an employee at a subsidiary had inflated sales figures, according to the wire service. Then in May 2007, officials at NEC said the company discovered that fraudulent transactions had been carried out by 10 employeestaking part in a tax assessment during the seven-year period ending March 31, 2006. The Japanese company, which was already embroiled in a major accounting scandal at the time, said that fraudulent transactions amounted to roughly $18 million.

The company explained at the time that NEC employees instructed contractors to create fictitious orders using the names of subcontractors. NEC’s employees received about $4.1 million in kickbacks from the subcontractors, and used it for personal purposes, noted the filing. Altogether, 17 contractors and subcontractors were involved.

NEC said it had been carrying out internal inquiries with the assistance of external lawyers since it was informed of the situation by the Tokyo Regional Taxation Bureau. As a result, the company said it was taking disciplinary action against the employees involved in the fraudulent transactions. In addition, the company is conducting further internal inquiries, and will evaluate whether it will seek compensatory damages or filing a criminal complaint.

The fraudulent transactions involved the trading of intangible assets such as services and construction. The company explained that the fraud was not discovered for some time because the system enabled validation of the orders through confirmation by the same employees that made the orders. In response to the controls deficiency, NEC established a system at the end of last year by which confirmation is carried out by a third-party administrative division, it added last May.