The recently settled SEC/Cablevision action provides a couple of insights into the SEC's practices. One insight is how the SEC settles actions involving financial statement errors that companies voluntarily bring to the SEC's attention. Another is what the SEC considers a material misstatement--in this case, 3.8% of after tax earnings. Another insight might be how easy it was for the officers of Cablevisions's subsidiary to misstate the financials.
Three former employees of Cablevision Systems Inc. were fined a total of $60,000 as a result of accounting irregularites from 2000-2003. The employees did not admit or deny wrongdoing. The three officials were the president, executive vice president and senior vice president of a subsidiary. They were dismissed in 2004, when Cablevision discovered the errors.
Cablevision is a diversified entertainment and telecommunications company with a market cap of approximately $8 billion and 2007 annual revenues of $6.5 billion.
As a result of the an income smoothing scheme the SEC's order stated that Cablevision’s financial statements for years 2000 through 2003 were materially inaccurate. The total after-tax errors were:
$15 million understatement 2000 (3.8% of earnings)
$25 million overstatement in 2001 (1.5% of earnings)
$8 million overstatement in 2002 (4.9% of earnings)
$8 million overstatement in 2003 (5.1% of earnings)
From 1999 through 2003, Cablelevision recognized certain costs as current expenses when, in fact, the costs should not have been recognized in those periods. These improper "prepays" resulted from fake invoices generated to accrue expenses earlier than when they in fact should have been. The result was that Cablevision overstated expenses in earlier periods, and understated them in later periods. This practice is generally known as "income smoothing".
In addition, from 2000 through 2003, Cablevision’s cable distribution business improperly recognized payments known as launch and marketing support paid to Cablevision by television program vendors for advertising and marketing campaigns to attract viewers to the vendors’ programs. This scheme caused Cablevision to reduce expenses in the periods in which launch support was improperly recognized and increase expenses in the periods when the launch support should have been recognized.
Improper Prepays
Cablevision’s accounting department, however, had little direct knowledge of the type of details discussed below at a business unit level. Internal accounting procedures merely called for recognition of expenses and requests for payment of expenses to be reported to the accounting department on a standardized "authorization for payment" form ("APF"), signed by the appropriate level business unit manager, with evidence of the expense, such as an invoice, attached. These controls, however, were not sufficient to prevent the manipulation of expense recognition that occurred.
Cablevision’s accounting department, however, had little direct knowledge of the type of details discussed below at a business unit level. Internal accounting procedures merely called for recognition of expenses and requests for payment of expenses to be reported to the accounting department on a standardized "authorization for payment" form ("APF"), signed by the appropriate level business unit manager, with evidence of the expense, such as an invoice, attached. These controls, however, were not sufficient to prevent the manipulation of expense recognition that occurred.
Cablevision employees and managers for years were able to defeat Cablevision’s internal accounting controls using methods that were neither particularly devious nor sophisticated. For example, some employees submitted counterfeit invoices to Cablevision’s accounting department that were of noticeably poor quality, and were different in appearance from legitimate invoices. Certain Cablevision employees also asked vendors to submit false, vague or misdated invoices for services not yet provided. These invoices were used to trigger the inappropriate patments. In addition, Cablevision checks were sometimes sent to the business unit from which a counterfeit or false invoice originated, ostensibly for delivery to the vendor by an employee of the business unit. This deficient practice permitted the business unit to hold payment until the anticipated services were actually rendered.
Improper Launch Support Recognition
Beginning in the middle to late 1990s, television program vendors began providing lump-sum launch support payments to Cablevision in connection with multi-year contracts with Cablevision to carry their programs. Contract provisions concerning launch support payments were generally understood to require Cablevision to use the funds for advertising and marketing campaigns to attract viewers to the vendors’ programs. Contracts providing for large up-front payments of launch support to Cablevision were not uncommon. These contracts sometimes also required that the launch support be refunded by Cablevision if, among other things, it dropped the program.
In some cases during the relevant period, Cablevision properly recognized nonrefundable launch support as a reduction of expenses ratably over the life of the contract with the vendor and recognized refundable launch support ratably over the life of the refund period. In fact, in 2002, Cablevision publicly stated that this was how it accounted for launch support. From 2000 through the third quarter of 2003, however, Cablevision improperly accelerated the recognition of launch support received from several program vendors, rather than recognizing it ratably over the life of the contract or the refund period. This early recognition ran contrary to its general practice and its 2002 public statement, and violated GAAP’s matching principle.
For example, after the first two years of an eight-year contract, Cablevision changed its recognition for $15 million of launch support from recognition ratably over the life of the contract to immediate recognition of the remaining balance. Under the circumstances, however, Cablevision should have accounted for launch support payments ratably over the life of the contract where, as here, the contract term was fixed and there was no obligation to refund launch support. Another example involved a contract with a launch support refund period. After the first eight months of a 24 month refund period, Cablevision changed its recognition of $5 million in launch support from recognition ratably over the life of the refund period to immediate recognition of the remaining balance. Under the circumstances, however, Cablevision should have accounted for launch support ratably over the refund period specified in the contracts.
Cablevision also improperly recognized launch support early by treating a 2002 seven-year agreement to carry certain programs as if it were two agreements – one of three years, and another of seven years. As two separate agreements, Cablevision recognized $48 million in launch support over the ‘three year’ agreement ($16 million per year), and recognized $16 million in launch support over the ‘seven year’ agreement ($2 million per year). Under GAAP, however, the two agreements should have been treated as one agreement, with the result that the total $64 million in launch support should have been recognized ratably over seven years, i.e., approximately $9.14 million per year. The purported two agreements were negotiated simultaneously and dated only five days apart, and the ‘seven year’ agreement also amended the terms of the ‘three year’ agreement. Cablevision employees improperly cast the single deal as two agreements to achieve early recognition of the launch support payments.
