Kehoe Law Firm, P.C. is making investors aware that on February 19, 2020 the SEC announced charges against against alcohol producer Diageo plc (“Diageo”) for failing to make required disclosures of known trends relating to the shipments of unneeded products by its North American subsidiary to distributors. Diageo has agreed to pay $5 million to settle the action.
According to the SEC’s order, employees at Diageo North America (“DNA”), Diageo’s largest and most profitable subsidiary, pressured distributors to buy products in excess of demand in order to meet internal sales targets in the face of declining market conditions. The resulting increase in shipments enabled Diageo to meet performance targets and to report higher growth in key performance indicators that were closely followed by investors and analysts.
The SEC’s order found that Diageo failed to disclose the trends that resulted from shipping products in excess of demand, the positive impact the overshipping had on sales and profits, and the negative impact that the unnecessary increase in inventory would have on future growth. The order further found that investors were instead left with the misleading impression that Diageo and DNA were able to achieve growth in certain key performance indicators through normal customer demand for Diageo’s products.
The SEC’s order found that Diageo violated the antifraud provisions of Section 17(a)(2) and (3) of the Securities Act of 1933, as well as certain reporting provisions of the federal securities laws. Without admitting or denying the findings in the SEC’s order, Diageo agreed to cease and desist from further violations and to pay a $5 million penalty.
According to the Summary of the SEC’s order:
1. In its fiscal years 2014 and 2015, Diageo failed to make required disclosures of known trends and uncertainties, thereby rendering its required periodic filings materially misleading to investors with respect to its financial results. During those periods, employees at Diageo’s largest and most profitable subsidiary—Diageo North America, Inc. (“DNA”)— pressured distributors to buy products in excess of demand to meet performance targets in a flagging market. As a result, distributors in North America held substantial unneeded inventory, which was a known trend or uncertainty: the continued selling over demand was unsustainable because it was likely that distributors would purchase less product in future periods. Diageo’s periodic filings did not disclose these known trends and uncertainties to investors.
2. The DNA employees’ “overshipping” of certain products to counteract the impact of declining market conditions and to meet performance targets allowed Diageo to report higher growth in certain of its key performance indicators. These indicators included organic net sales growth and organic operating profit growth, financial metrics closely followed by investors and analysts. DNA’s overshipping was also a factor in causing Diageo or DNA to meet or surpass analysts’ expectations for these two metrics.
3. By early fiscal 2015, certain distributors’ inventory positions became unsustainable and they began pushing back on orders. In response, DNA designed and implemented, and Diageo approved, a plan to reduce inventory levels. Under newly agreed-to contractual terms with certain distributors, DNA planned to correct the elevated inventories over a period of years, principally through a reduction in shipments to distributors, a process known as “destocking.”
4. Diageo did not disclose the known trends and uncertainties created by DNA’s overshipping and elevated distributor inventory levels because it did not have sufficient procedures in place to consider whether DNA’s overshipping or distributor inventory builds were trends or uncertainties that needed to be disclosed. As a result, Diageo failed to disclose significant known trends and uncertainties in its 2014 and 2015 Forms 20-F. In particular, Diageo did not disclose DNA’s overshipments versus demand and the resulting distributor inventory levels; the positive impact those trends had on organic net sales and organic profit growth, and the negative impact they were reasonably likely to have on future sales; and the fact that they caused Diageo’s and DNA’s reported financial information to not be indicative of future operating results or financial condition. These omissions also rendered misleading certain statements the company made concerning its and DNA’s financial performance.