On September 25, 2023, the Securities and Exchange Commission announced settled cease-and-desist charges against GTT Communications, Inc. (“GTT”), a formerly publicly-traded multinational telecommunications and internet service provider company. The SEC charged GTT with failing to disclose material information regarding unsupported accounting adjustments, which caused the company’s statements to be misleading with respect to its cost of revenue.
According to the SEC’s order, GTT did not face a civil penalty because of its prompt self-reporting, substantial cooperation, and voluntary affirmative remedial measures. This action is consistent with the SEC’s messaging on cooperation as a mitigation tool in avoiding or lessening penalties.
The SEC’s Allegations
The SEC’s allegations, which GTT neither admitted nor denied, were that, after a series of acquisitions in 2017 and 2018, GTT experienced difficulty integrating the newly-acquired companies into its operating and accounting systems. GTT used one operating system to manage customer orders, inventory, and billing, and used data in that system to estimate its projected cost-of-revenue. GTT used another system to process vendor invoices. By mid-2018, GTT noticed “a persistent and growing discrepancy” between the amounts it was actually paying in invoices through one system and the cost-of-revenue that was being estimated in the other system, raising questions about whether GTT’s accounting methodology was working correctly and whether its systems had data integrity problems. While GTT employees were aware of the issue, the company lacked the resources to manually reconcile each invoice.
According to the SEC, GTT accountants, operations employees, and senior management understood that the company lacked a reliable data source and the resources to properly report and record cost-of revenue. Despite this, the SEC alleged, GTT did not disclose that certain accounting adjustments were “unsupported and highly uncertain” as a result of these issues, rendering the company’s SEC filings materially misleading. Moreover, the SEC contended that this rendered misleading other disclosures about cost-of-revenue and vendor disputes.
The SEC alleged the following adjustments were misleading:
- In the third quarter of 2019, GTT shifted $5.6 million of expense from the income statement to the prepaid expenses on the balance sheet because employees “suspected” that the discrepancy between systems was resulting in the overstatement of cost-of-revenue. They had no reasonable basis, however, to quantify the impact of that discrepancy, and thus the adjustment lacked reasonable support.
- In the fourth quarter of 2019, GTT made a $16 million adjustment to account for disputed vendor invoices related to the systems discrepancy, but provided “no meaningful disclosure” regarding the methodology for the adjustment, which differed markedly from the company’s disclosed methodology for handling normal course disputes. Moreover, GTT maintained the $16 million adjustment even after its accountants received information—after the adjustment was booked but before the annual report was filed—which indicated that the adjustment should have been reduced by almost $7 million.
- In the first quarter of 2020, GTT again failed to disclose material facts when it reassessed disputes and processed two unsupported adjustments amounting to $19 million.
According to the SEC’s Order, in late 2020, GTT disclosed that its financial statements for 2017-2019 and the first quarter of 2020 should no longer be relied upon and that it intended to file restated financial statements. The company also disclosed that it had identified problems with the recording and reporting of its cost-of-revenue and was conducting an internal investigation. After spending “more than a year and tens of millions of dollars in an attempt to correct its filings,” GTT gave up, “due in part to the complexity of reconciling the two operational systems that were producing inconsistent information” related to cost-of-revenue. In 2021, GTT’s stock was delisted from the New York Stock Exchange, and the company terminated its registration with the SEC and filed for Chapter 11 bankruptcy, emerging at the end of 2022 as a private company. The SEC charged GTT with negligence-based violations of the antifraud provisions of federal securities law as well as violations of reporting, books and records, and internal control provisions. GTT was ordered to cease and desist from violations of the securities laws, but was not ordered to pay a penalty. In announcing the enforcement action, the SEC touted the no-penalty outcome, saying that it had not assessed a penalty because of GTT’s “prompt self-report, extensive remediation, and substantial cooperation.” GTT’s substantial cooperation included providing multiple presentations on the findings of its internal investigation, “including presentations made before it had reached final conclusions about the nature and scope of the relevant issues,” identifying key documents and witnesses, and facilitating testimony from former employees. The SEC also noted GTT’s remedial action in the form of “attempting to rebuild” its cost-of-revenue accounts, replacing members of management, its board of directors, and its auditor, and “overhauling its accounting function.”
The SEC’s settlement action is notable in several respects.
- GTT’s circumstances highlight how companies are not subject to a “grace period” when acquiring other companies. Instead, they must act quickly to address lack of controls and bring those systems up to speed.
- This case underscores that the SEC’s interest in early self-reporting, even before there has been a thorough internal investigation, “[a]t a time when [the company] was still evaluating the nature and impact of the accounting issues it had identified.”
- Despite the SEC’s emphasis on self-reporting and cooperation as a favorable factor in its assessment of penalties, it is important to note the particular circumstances under which the SEC has been willing to avoid civil penalties. The most notable recent no-penalty cases involved both extraordinary cooperation and considerable doubt that the company would have had the resources to pay a meaningful penalty in any event, as was the case with recently-bankrupt GTT. While there is some precedent for the SEC foregoing a penalty against a company that provided extraordinary cooperation and has the resources to pay, those cases involved less serious charges, such as the failure to report executive perks or failures in internal controls that did not result in materially misleading statements.
- Finally, the nature of this case highlights the need for employees to have clear and defined roles. In its Order against GTT, the SEC repeatedly emphasized the “knowledge disconnect” between operations and accounting employees, as well as confusion as to whether certain tasks were operations or accounting responsibilities. Because negligence can be sufficient to establish violations of the securities laws, unclear lines of communication and responsibility can create a risk of violations.
 https://www.sec.gov/news/press-release/2022-31; https://www.clearyenforcementwatch.com/2021/09/two-recent-settlements-highlight-heightened-sec-focus-on-accounting-fraud-and-potential-benefits-of-cooperation/.
 Last year, Tupperware Brands Corporation paid a $900,000 penalty for internal controls and books and records violations resulting from its alleged failure to integrate a newly acquired Mexican company into its system of internal controls, allowing the subsidiary to continue to make unsupported accounting entries that did not comply with corporate policy. See https://www.sec.gov/enforce/34-95943-s.
 The SEC also did not order a penalty in the 2022 case of technology start-up Headspin, Inc., whose CEO allegedly raised tens of millions of dollars from investors while fraudulently inflating the company’s valuation by hundreds of millions of dollars. In response, the company’s Board of Directors conducted an internal investigation, overhauled governance, fired the CEO and cooperated in the criminal case against him, revised the company’s valuation, and returned or promised to return practically all of the money raised from investors under false pretenses. The SEC may well have concluded that a penalty would interfere with the company’s promise to repay its investors. See https://www.sec.gov/news/press-release/2022-14.
 See https://www.sec.gov/news/press-release/2023-111(no penalty in executive perks reporting case against Stanley Black & Decker Inc. after company self-reported before completion of internal investigation); https://www.sec.gov/news/press-release/2021-244 (no penalty in executive perks reporting case against ProPetro Holding Corp., where company overhauled board, management, and accounting teams); https://www.sec.gov/news/press-release/2018-277 (no penalty in internal controls, books and records case against The Hain Celestial Group, Inc. after company self-reported, conducted internal investigation).