Opinion ID: 2999720
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Heading Rank: 1

Heading: Akorn’s Financial Reports and SEC Filings

Text: Akorn is a corporation that manufactures and sells diagnostic and therapeutic pharmaceuticals. During the time relevant to this proceeding, Akorn’s customers included both pharmaceutical wholesalers and direct or enduse customers. However, the company’s profits were primarily from five major wholesale customers, which amounted to approximately 43% of its total sales and 60% of its gross accounts receivable as of December 31, 2000. Akorn’s customers would generally order products and be invoiced according to varying rates, corporate credits, and payment schedules. Invoices were typically twenty to thirty pages long. Payment schedules varied between thirty and ninety days, with larger wholesalers generally enjoying longer payment terms than direct customers. Akorn classified its payment schedules as current, thirty to sixty days past due, sixty to ninety days past due, and over ninety days past due. Akorn, however, did not charge interest on overdue bills, thus minimizing the incentive for customers to remit payments in a timely manner. A customer payment to Akorn was accompanied by a remittance advice of up to 400 lines in length. A remittance advice explained the payment and, in some instances, asserted claims for a variety of credits that could apply to the order. In the late 1990’s, Akorn’s invoicing system was a labyrinth in which the company billed customers and processed No. 05-3510 3 cash remittances and credit claims against invoices at three different finance offices that used different computer programs and record-keeping mechanisms. In 1999, in an effort to centralize its finance, billing, and accounts receivable records, Akorn began using a software program called Macola. Akorn’s use of Macola was short-lived, as the software proved incapable of tracking the age of Akorn’s outstanding invoices, monitoring debits and credits applied to a particular customer account, and handling high-volume data management. In 2000, Akorn began using a J.D. Edwards software package. Rather than migrating its billing files from the Macola software to the J.D. Edwards software, Akorn recorded new receivables on the J.D. Edwards software, but the company did not transfer the existing Macola-tracked accounts. The result was a parallel system of bill tracking that used two different software modules. Petitioner Rita McConville served as chief financial officer (“CFO”) for Akorn from February 28, 1997 to March 20, 2001. As CFO, McConville reported to Akorn’s president and chief executive officer (“CEO”), Floyd Benjamin. McConville supervised Akorn’s corporate controller and its finance departments, and she worked with Akorn’s auditor, Deloitte & Touche LLP (“Deloitte”). As CFO, McConville was also, along with Akorn’s corporate controller, responsible for filing Akorn’s financial documents with the SEC. On February 25, 2000, Akorn’s auditor, Deloitte, sent a letter to its board of directors, alerting the board to anticipated problems in Akorn’s financial statements for the fiscal year ending on December 31, 1999. The report identified as particularly problematic Akorn management’s failure to review the accounts receivable in detail, misapplication of credits and payments to customer accounts, and failure to collect outstanding balances effectively and efficiently. The report also included a section entitled “Management Response,” which was drafted in part by 4 No. 05-3510 McConville, stating that management had begun an effort to reconcile all customer accounts, with a goal of “significant collection resolution by June 30, 2000 and complete cleanup by August 31, 2000.” Later in 2000, the disarray in Akorn’s financial department boiled over when a billing discrepancy arose between Akorn and its largest customer, Cardinal Health Incorporated, which represented 12% of Akorn’s net sales and 22% of its gross accounts receivable. Akorn’s records (based on invoices going back to 1999 when the Macola software was used) showed that Cardinal owed Akorn approximately $4 million. Cardinal’s records showed that it had a credit balance with Akorn of approximately $800,000, meaning the variance in the companies’ books differed by nearly $5 million. The chairman of Akorn’s board of directors and a major stockholder, John Kapoor, instructed McConville and the corporation’s CEO to meet with Cardinal and resolve the billing dispute. McConville took copies of the largest outstanding invoices to the meeting with Cardinal, leaving behind the invoices with smaller balances.1 During the meeting, McConville presented only the larger outstanding invoices to Cardinal for payment. After the meeting, Cardinal sent Akorn $ 913,000, which it viewed as full payment to settle any debt it owed and creating a credit balance with Akorn. Akorn, on the other hand, believed that many outstanding Cardinal invoices remained unpaid, and a March 15, 2001 letter from CEO Benjamin to Cardinal stated that there was still a discrepancy of more than $5 million to be reconciled between the Akorn records and the Cardinal records. (It is unclear from the record how the 1 McConville testified that she believed she took only invoices for more than $10,000 to the meeting with Cardinal. The Commission, however, noted other evidence in the record suggesting that the invoices McConville presented at the meeting were only those with balances of more than $ 50,000. No. 05-3510 5 discrepancy of just under $5 million before the meeting jumped to over $5 million after the meeting). Notwithstanding the lingering dispute between Cardinal and Akorn over the amount of Cardinal’s outstanding balance, if any, McConville reassured Akorn’s auditor Deloitte that the customer accounts were successfully being reconciled and that there was little past due money owing from wholesalers because most of the aging balances were offset by more recent credits.2 McConville also wrote a press release, dated February 20, 2001, announcing an approximate $ 2 million profit in Akorn’s fourth-quarter results. During February and early March, McConville also reviewed drafts of the 2000 financial statements. Still not satisfied with Akorn’s financial condition, Kapoor assigned McConville to work with a consultant hired by Kapoor to conduct a thorough analysis of Akorn’s accounts receivable and to submit a report discussing any potential write-offs of the receivables. On March 15, 2001, the consultant submitted a report to Kapoor, stating, in relevant part: The wholesaler accounts have never been worked. We are talking about an accumulation of problems over a 3 or 4 year period. This provides us with a legacy of pages and pages of A/R3 reports on each of those five accounts, consisting of a maze of transactions including: open invoices, partially paid invoices, billbacks, credits for return goods, credits for damaged goods, credits for shipments not received, credits for billing errors, rebate credits, 2 Joint Appendix at 413, McConville v. SEC, No. 05-3510 (7th Cir. Nov. 17, 2005). 3 “A/R” in the consultant’s report is shorthand for “accounts receivable.” 6 No. 05-3510 chargeback credits, deductions taken arbitrarily by the wholesaler, situations where the wholesaler used credits multiple times, and unapplied cash. These transactions go back as far as 1996. (Emphasis in original). The consultant further concluded that “there [we]re no quick fixes available” because “[n]o management reports exist that trend sales, cash, A/R aging, reserves, unbilled, or [days sales outstanding]. Therefore, the A/R could not have been properly monitored.” At the end of the day, the consultant concluded that “a determination on the collectibility will require a substantial amount of time (months) and work.” Although Kapoor instructed McConville to work with the consultant, McConville maintains that she never viewed the report or discussed its contents before it was submitted to the board of directors. On March 20, 2001, Akorn’s board of directors removed McConville from her position as CFO, and demoted her to corporate controller.4 As part of her new duties, McConville reported to incoming CFO Kevin Harris, and she was tasked with resolving the billing dispute with Cardinal. McConville also continued her work, the degree to which is disputed by the parties, compiling the figures for Akorn’s 2000 fiscal year audit for the financial statements that would be filed with the SEC. What is apparent from the record is that McConville’s input in the fiscal year 2000 financial statements began while she was CFO of Akorn.5 4 Also on March 20, 2001, the board of directors demoted Akorn’s CEO Floyd Benjamin to vice president, and Kapoor became the interim CEO. 5 McConville concedes that she had some input in drafting the financial statements while she was CFO, but she contends that the preparation of Akorn’s Form 10-K did not begin in earnest until after she was removed as CFO. McConville contends that her (continued...) No. 05-3510 7 As stated, during her tenure as CFO, McConville frequently reassured Akorn’s auditor, Deloitte, that the books would eventually balance out. She also regularly met with Deloitte representatives and reviewed preliminary draft figures for the financial statements. According to the Commission’s findings, by McConville’s last day as CFO on March 20, the financial statements were largely completed, and a draft of the 2000 Form 10-K, a document reporting a corporation’s financial health to the SEC, had already been prepared. The Commission also found that, as CFO, McConville reviewed a draft of the 2000 Form 10-K, the filing of which was delayed due to the consultant’s investigation.6 McConville, among others, signed two management representation letters in connection with Deloitte’s annual audit of the financial statements filed with the 2000 Form 10-K. The first letter, dated February 23, 2001, stated that, to the best of McConville’s knowledge: (1) other than those disclosed, no events had occurred subsequent to December 31, 2000 that required consideration as adjustments to or disclosures in the consolidated fin- ancial statements; (2) management believed the credit allowances were adequate to absorb currently estimated uncollectible receivables in the account balances; and (3) management had reviewed the financial statements for 5 (...continued) involvement in drafting the Form 10-K was limited to preparing a single footnote pertaining to the corporation’s stock options. 6 McConville contends that she did not see a draft of the 2000 Form 10-K during her tenure as CFO. However, the Commission deferred to the administrative law judge’s finding that McConville’s testimony to that effect was incredible, and that she did in fact review a draft of the Form 10-K while she was CFO. And, as we explain below, our review of the Commission’s finding is highly deferential. 8 No. 05-3510 impairments of Akorn’s assets, and no adjustment to the statements was required.7 Notably, McConville admits that the task of resolving the Cardinal billing dispute was “far from complete on April 17, 2001.”8 However, the second letter she signed, dated April 17, 2001, stated that “there are no events which have occurred subsequent to February 23, 2001 that have a material effect on the financial statements that are in the filing or that should be disclosed in order to keep those statements from being misleading.”9 That same day, Akorn filed the 2000 Form 10-K with the SEC, reporting a net income of $2,187,000, current assets of $42,123,000 (as of December 31, 2000), and accounts receivable of $24,144,000, which amounted to approximately 57% of Akorn’s then-current assets. McConville did not sign the Form 10-K. On May 22, 2001, a month after filing the Form 10-K, Akorn filed its quarterly report, Form 10-Q, for the quarter that ended on March 31, 2001. In its Form 10-Q, Akorn increased by $7.5 million its allowance for doubtful accounts, that is accounts with balances unlikely to be recovered. McConville’s employment with Akorn terminated in July 2001. Over a year later, on October 7, 2002, Akorn restated its financial statements for 2000 and 2001 by filing a Form 10-K/A. The Form 10-K/A stated that Akorn “had not adequately considered all of the information available with respect to certain disputed receivables in establishing its allowance for uncollectible accounts as of December 31, 2000,” and the $7.5 million increase in its allowance for 7 Joint Appendix at 388-392, McConville v. SEC, No. 05-3510 (7th Cir. Nov. 17, 2005). 8 Brief of Petitioner-Appellant at 19, McConville v. SEC, No. 053510 (7th Cir. Dec. 6, 2005). 9 Joint Appendix at 396, McConville v. SEC, No. 05-3510 (7th Cir. Nov. 17, 2005). No. 05-3510 9 doubtful accounts should have been recorded at the end of 2000, rather than in the 2001 Form 10-Q. At the end of the day, once the financial statements were corrected, Akorn sustained a net loss of $2.4 million in 2000, rather than a gain of $2 million as it had originally reported in its Form 10-K.