SEC Charges Company And Finance Executives With Raiding The Cookie Jar – Corporate/Commercial Law

Just in time for the holidays-cookie jars full of…revenue
adjustments! In this complaint, the SEC charged American Renal
Associates Holdings, Inc., a national provider of dialysis
services, and three of its finance executives with securities fraud
and other misconduct. According to the SEC, the alleged fraudulent
scheme involved a “series of revenue adjustments to make it
appear that ARA had beat, met, or come close to meeting various
predetermined financial metrics, when in fact its financial
performance was materially worse.” After receiving an inquiry
from the SEC, ARA conducted an internal investigation that led the
company to restate its financials, which, according to the SEC,
showed that the company had overstated its net income by over 30%
for 2017 and by more than 200% for the first three quarters of
2018. The revenue adjustments in the cookie jar, the SEC charged,
were one of the key ingredients used in this alleged effort to cook
the company’s books.

ARA owned and operated dialysis clinics through joint ventures
with doctors across the country, with the doctors providing patient
care and ARA handling billings, collections, revenue management and
patient insurance matters. Insurance reimbursement for dialysis
treatments was a major component of ARA’s revenue. ARA was
traded on the NYSE until it was acquired by a private equity firm
in 2021. Key metrics for the industry were DSO, or days sales
outstanding, and RPT, or revenue per treatment, as well as adjusted
EBITDA-NCI (excluding non-controlling interests). According to the
SEC, these metrics were especially important to investors and
analysts, and ARA regularly touted its performance on these
metrics, such as its consistently low DSO, to potential new doctors
and in its SEC filings and earnings calls.

As described in the complaint, at the core of the alleged fraud
was the company’s methodology for estimating and using
“topside adjustments.” For companies with which ARA had a
contract, ARA could simply book revenue at the pre-determined
rate.  However,  where there was no contract or
agreed-upon rate, ARA used a two-step process: First, ARA made an
initial estimate of revenue that it would receive. Second, 
ARA would make a “revenue adjustment to true up the initial
estimate to the amount actually collected,” as required by
GAAP. These adjustments, which could be positive or negative, were
called “topside adjustments.” Under ARA’s 
stated methodology as described in the company’s internal
accounting controls, topside adjustments were to be based on a
detailed patient-level analysis that entailed “a comparison of
the actual payments received for a particular patient’s course
of treatment to the prior estimates of what those payments would

The SEC alleged that, after the departure of the former COO (who
apparently followed a process for topside adjustments with which no
one seemed familiar, but is not a subject of the complaint) at the
end of 2016, the finance executives developed their own process for
revenue recognition and topside adjustments, which the SEC
characterized as “little more than a fraudulent scheme
[to book] millions of dollars in topside adjustments that were not
based on patient-level detail, but instead booked to meet
predetermined financial metrics….[The executives’] decision
to use this top-down approach, not based on any patient-level
detail, was highly unreasonable and represented an extreme
departure from the standards of ordinary care.” This decision,
the SEC charged, to use a “top-down approach to book the
revenue [an executive] wanted ARA to have, rather than building
revenue up from actual patient-level data, was the heart of the
topside scheme.”  Other allegedly improper accounting
practices identified by the SEC to be part of the scheme were
“a) banking identified topside adjustments for use in future
quarters, b) spreading out topside adjustments across multiple
months, including across different quarters, and c) finding and/or
creating offsetting topside adjustments between clinics in order to
have a net zero effect on overall revenue and DSO.” 

In particular, the executives created a “Contractual
Adjustments” spreadsheet, which, the SEC alleged, functioned
as a “cookie jar” that ARA used to “find topside
revenue when needed. (See this PubCo post and this PubCo post for discussions of other cases
involving cookie jars.) As of July 2018, ARA had identified $35.7
million in net overcollections related to services performed in Q2
2018 or earlier, but had only recorded $29.6 million by the end of
Q2 2018. The remaining $6.1 million, comprised of $10.2 million in
unbooked over-collections and $4.1 million in un-booked
under-collections, was carried forward into future quarters by
means of the cookie jar Contractual Adjustments spreadsheet.”
As alleged by the SEC, the improper topside process was used to
target DSO, as well as to achieve a specific target for
consolidated RPT. To that end, the SEC charged, one of the
executives instructed another to “find” enough revenue in
topside adjustments to achieve ARA’s budgeted RPT metric, about
$3 million in topside adjustments. The SEC cited in support
internal emails carrying out that instruction and an employee (who
was subsequently fired) questioning the propriety of the action.
The SEC also alleged that the executives failed to disclose their
topside adjustment practices to the company’s audit firm,
created false documentation to support their adjustment methodology
and signed false certifications.

The level of net topside adjustment continued to increase
dramatically through the first three quarters of 2018, representing
92% of reported net income and 280% of restated net income, when an
SEC inquiry led to an internal investigation and a financial
restatement “showing material changes in almost every
financial metric.”  According to the complaint, the
restatement admitted that the company had not complied with GAAP
and had material weaknesses in its internal controls. The stock
price dropped.

According to the complaint, the finance executives received
inflated equity and cash bonuses based on financial statements that
falsely reflected achievement of performance metrics.  (As a
result of the restatement, the company’s former CEO, who was
not charged, returned almost $900,000 in compensation.)

The SEC’s complaint makes 16 claims against the defendants,
including violations of the antifraud provisions of Section 17(a)
of the Securities Act and Section 10(b) of the Exchange Act;
Section 13(a) and Rules 12b-20, 13a-1, 13a-11 and 13a-13 for
reporting violations; Section 13(b)(2)(A) for failure to maintain
accurate books and records; Rule 13b2-1 for falsifying books and
records; and Exchange Act Sections 13(b)(2)(B) and 13(b)(5) for
failure to maintain adequate, and knowingly circumventing, internal
accounting controls. Most of these claims also included separate
aiding and abetting claims against some or all of the finance
executives. The complaint also charges some or all of the finance
executives with making false statements to auditors, including
signing false management representation letters, in violation of
Rule 13b2-2(a) and signing false certifications in violation of
Rule 13a-14. There were also charges under the clawback provisions
of SOX 304(a), as a result of the restatement due to

ARA agreed to settle by consenting to a permanent injunction and
a $2 million civil penalty, all subject to court approval. 
The SEC is seeking permanent injunctive relief, disgorgement with
prejudgment interest, civil penalties, reimbursement under SOX
304(a) and officer and director bars against the finance

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