Enforcement News: SEC Files Action Against a Trucking Company for an Accounting Fraud That Allowed the Company to Mispresent its Financial Condition

• Posted on: Apr 29 2019

On April 25, 2019, the Securities and Exchange Commission (“SEC”) announced (here) that it had charged Indianapolis-based Celadon Group Inc. (“Celadon”), a truckload freight transportation provider, with an accounting fraud that allowed it to avoid disclosing substantial losses and misrepresent its financial condition.

The SEC alleged (here) that, between mid-2016 and April 2017, Celadon avoided recognizing at least $20 million in impairment charges and losses – almost two-thirds of its 2016 pre-tax income – by selling and buying used trucks at inflated prices from third parties.  According to the complaint, as a result of the alleged scheme, Celadon overstated its pre-tax and net income and earnings per share in its annual report for the period ending June 30, 2016, and in its subsequent public filings for the first two fiscal quarters of 2017.

The SEC’s case against Celadon is the latest in a line of actions brought against companies or their executives for committing accounting fraud, by entering into sham agreements with third-parties, suppliers or customers. See SEC v. Tangoe, Inc. et al., 3:18-cv-01479 (D. Conn. 2018); SEC v. Axesstel, Inc., et al., 3:18-cv-01486-L-AGS (S.D. Cal. 2018); SEC v. Bhushan Dandawate, No. 18-cv-4927 (N.D. Ill., 2018); SEC v. Quadrant 4 System Corp., et al., No. 17-cv-4883 (N.D. Ill., 2017).

The Basics of the Alleged Fraud

Celadon owned more than 1500 tractor trucks – the front of a “tractor trailer” containing the engine. These trucks required costly maintenance. As a consequence, the company developed a cost-containment strategy, which involved, in part, Celadon continuously refreshing its fleet – newer trucks cost less to maintain.

In mid-2016, the “net book value” for many of its trucks – i.e., the value Celadon had attributed to the trucks in its internal bookkeeping – greatly exceeded the amount the trucks could have actually been sold for in the open market. Therefore, alleged the SEC, if Celadon sold these trucks for less than its net book value, Celadon would have had to recognize the shortfall as a loss on its financial statements.

Given the hundreds of trucks involved, Celadon’s resulting losses either through sale or by adjusting net book values to fair values (also known as “impairment charges”) would have been significant. To avoid having to recognize such charges, claimed the SEC, Celadon orchestrated a fraudulent scheme.

According to the complaint, Celadon found a truck dealer (“Party A”) to buy hundreds of used trucks at the inflated net book values. In some cases, the company sold the trucks for even more than the already inflated book values in order to claim a profit from the sales.

In some cases, the value that Celadon was carrying on its books for a truck was more than double what it could have actually received in the open market. Celadon sold many of its trucks to Party A for prices substantially in excess of their fair value.

Consequently, the price Celadon paid Party A for the newer trucks was similarly inflated – in certain instances approximately triple their fair value. In several instances, said the SEC, Party A purchased trucks with the express purpose of selling them to Celadon.

Between June and October of 2016, Celadon sold more than 900 trucks to Party A and purchased more than 600 trucks from Party A. The prices in these transactions were at least $20 million more than the trucks were worth.

According to the SEC, by failing to recognize impairment charges on its trucks, Celadon materially overstated the value of its assets and, by extension, materially overstated its income before income taxes, net income and earnings per share in various public filings between 2016 and 2017.

The Alleged Violations and Relief Sought

The SEC charged Celadon with fraud and with reporting, books and records, and internal control violations. Celadon admitted to those violations and agreed to a permanent injunction and to remediate the material weaknesses in its internal control over financial reporting. Celadon agreed to pay $7 million in disgorgement, which the SEC will consider to be satisfied by Celadon’s payment of restitution in a criminal matter brought by the Department of Justice (here). In that matter, Celadon entered into a deferred prosecution agreement, pursuant to which the company agreed to pay $42.2 million in restitution.

The settlement with the SEC is subject to court approval.

SEC v. Celadon Group, Inc., Case 1:19-cv-01659-RLY-MJD (S.D. Ind. 2019).

Tagged with: Accounting Fraud, SEC, SEC Enforcement Proceeding, Securities