Risk Management

SEC Zeroes In on Sale-leasebacks

The regulator settles with two companies, Terex and GE, over alleged schemes to recognize revenue prematurely.
Sarah JohnsonAugust 13, 2009

The Securities and Exchange Commission has settled a four-year-old case against a construction-equipment manufacturer for a string of alleged fraudulent schemes that resulted in criminal charges for two CFOs and civil charges against a third.

Yesterday the SEC announced that Terex will pay $8 million to settle charges that it helped United Rentals develop and conceal transactions so that the companies could recognize a chunk of revenue just before their fiscal years ended in 2000 and 2001.

Under generally accepted accounting principles, United Rentals should have recorded the revenue in a later period because it hadn’t completely let go of the risks and rewards tied to the assets it had sold to a financing company, which then offloaded them to Terex.

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It was a similar type of deal that got General Electric into trouble. The mammoth corporation — historically renowned for financial integrity — agreed last week to settle SEC charges of fraudulent hedge-accounting practices and revenue-recognition schemes involving sale-leaseback deals for $50 million several years ago.

Asked whether sale-leaseback transactions are becoming a focus for the SEC, Kenneth Lench, assistant director of its enforcement division, demurred. “I wouldn’t necessarily agree or disagree with that,” he told CFO.com. “We find all kinds of accounting issues. There are all kinds of ways that companies can prematurely recognize revenue or recognize revenue when they shouldn’t. In those cases, we will take action.”

Under sale-leaseback agreements, one company sells an asset — such as real estate or equipment — to a third party to get quick cash, offload the asset from its balance sheet, or reduce risks associated with the asset. The third party then leases it back to the seller, and in turn typically receives a long-term stream of interest payments.

However, in the United Rentals and GE cases, the companies allegedly got third parties to help them use these transactions to falsely keep their revenue numbers up and meet earnings targets.

Under GAAP rules, sellers have to wait until sold products are delivered before they can record the revenue. And, according to the SEC’s complaint against GE, “[d]elivery is not considered to have occurred unless the customer has taken title and assumed the risks and rewards of ownership.”

GE sold locomotives to financial institutions through six transactions, designed, the SEC says, to let the company recognize revenue before its railroad customers were ready to buy the equipment. The assumption was that the institutions would resell the locomotives to GE customers the following quarter. The problem was, GE hadn’t ceded ownership of the assets; under the deal, GE had agreed to maintain them on its property to prevent damage from the cold and keep them secure, the SEC says.

The SEC has not yet said if charges will be filed against the financial institutions that were involved in the GE transactions.

Meanwhile, Terex, which in contrast to GE was on the receiving end of its sale-leasebacks with United Rentals, “knew or was reckless in not knowing” that the deals would conceal United’s risk and financial obligations tied to the transaction.

Last September United Rentals agreed to pay $14 million to settle charges that it conducted fraudulent sale-leaseback transactions in a three-party, two-part scheme. John Milne and Michael Nolan, former United Rentals CFOs, have also faced related SEC and criminal charges. Milne has pleaded guilty in federal court to submitting false filings with the SEC and awaits sentencing. Former Terex CFO Joseph Apuzzo faces SEC aiding and abetting charges.

The two transactions between the companies were similar. United Rentals sold used equipment to a financing company (the SEC won’t identify it), which was set to receive a fee and a guarantee from Terex that it would resell the equipment when the eight-month leasing period was over. Terex also expected United Rentals to indemnify it against any losses from the deal and to buy new equipment from it. Because of these obligations, United Rentals should not have recorded revenue when it did, the SEC says. In addition, it’s been alleged that the companies worked together to hide these agreement terms from United Rentals’s auditor.

In a statement made Wednesday, Terex said: “the settlement resolves all matters relating to the potential liability of Terex, but does not address current or former employees.” The SEC had also accused the company of failing to resolve imbalances derived from intercompany transactions. As part of the settlement, Terex has consented to be permanently enjoined from violating the antifraud, reporting, books and records, and internal-control provisions of the securities laws.