Engine Manufacturing Executives Charged in Fraudulent Revenue Recognition Scheme

October 2019
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Parallel charges filed by the SEC and DOJ in July 2019 alleged that the former CEO and two former sales executives of Power Solutions International, Inc. (“PSI”), a publicly traded engine manufacturer, fraudulently inflated PSI’s revenue by recording sales of products that were not complete, that the customer had not agreed to accept, and for which the price was falsely inflated. The SEC also alleged that PSI recorded sales from improper “bill and hold” arrangements and that the executives misled and concealed information from PSI’s internal accountants and external auditors in an effort to meet the company’s revenue targets. The executives are no longer employed by PSI, which is said to be cooperating with the investigation. In May 2019, PSI restated its financial statements for fiscal years 2014 and 2015, which reflected a reduction in revenue of approximately $25 million. To date, the government has not brought charges against PSI in connection with the matter.

  • Emphasis on Meeting Revenue Targets – According to the SEC’s complaint, demand for PSI’s products was tied to the price of oil because many of PSI’s largest customers purchased engines to be used in the oil and gas industry. When the price of oil was depressed in 2015, it became increasingly difficult for PSI to meet its revenue targets, which led the executives to engage in aggressive accounting practices. The order describes “end-of-quarter drives to hit revenue targets” in which the executives incentivized customers to place orders for products that they did not need, and to accept products earlier than desired. For example, during the first quarter of 2015, PSI recorded revenues of approximately $7.8 million “for the purported sale of engines to a customer that was given an indefinite, open-ended right to return the engines if it did not need them.”
  • Concealment of Fraudulent Accounting – The SEC’s complaint alleges that the PSI executives concealed their fraudulent revenue recognition practices from the company’s internal accounting team and external auditors by not informing them of key information regarding certain sales transactions, including the existence of side agreements and right of return arrangements with customers. In many instances, the management representation letter that the company’s CEO signed for the external auditor falsely stated that such arrangements had been shared with the auditor – likely a key factor in the government’s decision to bring criminal charges. When the revenue recognition practices were reported to the audit committee and board, PSI commenced an internal investigation in the summer of 2016. The SEC alleged that the CEO’s misconduct continued during the internal investigation – both by characterizing the basis for the investigation as meritless and by making false statements regarding the merits of the accounting practices to PSI’s chief legal officer, which were ultimately shared with the company’s auditors.

The SEC’s complaint can be found here.

The DOJ’s indictment can be found here.

View the full Accounting & Financial Reporting Enforcement Round-Up.