This press release announces settled charges brought by the SEC against GTT Communications, Inc., a multinational telecommunications and internet service provider, for failure to disclose material information about “unsupported adjustments of more than $35 million” that had the effect of reducing COR, i.e., cost of revenue, and increasing reported operating income by at least 15% in three quarters from 2019 through 2020. According to the Order, in 2017 and 2018, GTT rapidly expanded its business through multiple acquisitions, but had difficulty absorbing and integrating the operations of the acquired, sometimes distressed, companies, especially with regard to accounting and controls. As a result, GTT was never able to reconcile data from two critical operating systems used to determine COR, ultimately leading to data integrity issues in its financial statements. In an attempt to achieve some consistency between the two systems, the SEC alleged, the company began to make accounting adjustments that, in the absence of effective controls, were “highly uncertain” and devoid of proper support. Moreover, the SEC alleged, GTT failed to provide adequate disclosure about the adjustments. In addition to antifraud violations, the SEC charged GTT with control violations: although GTT knew that its systems were inadequate to accurately report COR, “GTT failed to implement and maintain policies and procedures designed to provide reasonable assurance that the COR reflected in GTT’s financial statements was based on reasonable support.” However, because of GTT’s prompt self-reporting, remedial measures and substantial cooperation, the SEC did not impose a civil penalty. But perhaps the real penalty can be found here: in 2021, GTT was delisted from the NYSE, terminated its Exchange Act registration and filed for bankruptcy. GTT emerged in 2022 as a private company owned by certain of its former creditors—but eligible to use “Fresh-Start Reporting.”
Background. According to the Order, between 2017 and 2018, GTT completed “eight acquisitions that more than doubled GTT’s revenue and expense. Many of the acquired companies were private, distressed companies located outside the United States that used different operating and accounting systems than GTT and that lacked robust internal controls. GTT’s employees were overwhelmed by the increased volume of data and transactions following the acquisitions and they struggled to successfully integrate certain of these newly acquired companies into GTT’s systems.” In particular, the integration problems related to two key operational systems—GTT’s bill processing system (“BPS”), a system designed to process vendor invoices that, for purposes of determining COR, “contained GTT’s expenses as reflected in the invoices received from the vendors,” and its Client Management Database (“CMD”), an internally developed platform that GTT used to manage its contracts with networks, clients and suppliers. As described in the Order, “CMD contained estimates of GTT’s anticipated COR derived from information about third-party vendor inventory used to fulfill services to its customers.”
In Q2 2018, GTT’s employees started to find increasing discrepancies between “the amounts GTT was routinely paying in invoices as reflected in the BPS and the expected costs that were reflected in CMD. This discrepancy between CMD and the BPS indicated that GTT’s accounting methodology was not working correctly and that its systems had data integrity issues.” GTT’s accountants and operations employees attempted on numerous occasions to get to the bottom of the discrepancy, but were unable to compare the data in the two systems effectively, nor did GTT have the resources, because of the large volume of data, to review the invoices manually. According to the Order, “GTT never resolved which data source should be used to record and report COR or which was more accurate.” By 2019, accountants and employees understood that the “only way to determine GTT’s actual COR was to link the data between CMD and the BPS at a granular level.” That didn’t happen.
Beginning in Q3 2019, “motivated by a desire to keep expenses consistent with CMD while it continued to investigate,” GTT began to make adjustments to COR. Although GTT knew “that it lacked both a reliable data source and the resources to manually review COR,” the SEC charged, “GTT failed to implement and maintain policies and procedures designed to provide reasonable assurance that COR adjustments were based on reasonable support.” In addition, GTT “failed to disclose material facts concerning certain unsupported and highly uncertain adjustments to COR” for three quarters, Q3 and Q4 of 2019 and Q1 of 2020. For example, in Q3 2019, although GTT had not determined the cause of the discrepancy in COR, GTT moved $5.6 million of expense from the income statement to prepaid expenses on the balance sheet, increasing prepaid expense and decreasing COR, with the result that GTT’s operating income increased by approximately 23% and its net loss before income taxes decreased by approximately 17%. Employees suspected the discrepancy was due to a problem with the BPS but, the SEC alleged, GTT did not have a reasonable basis to quantify the impact of the problem and did not disclose material facts concerning the adjustment.
Similarly, in Q4, the SEC charged, GTT failed to disclose material facts concerning an unsupported $16 million vendor dispute adjustment. In that quarter, GTT attempted to link invoices in the BPS to CMD, intending to dispute any invoices that could not be linked with vendors. GTT then took a $16 million adjustment based on estimated “win rates” for these “bulk disputes,” despite having no history with bulk disputes (as opposed to normal course disputes), and notwithstanding internal conflicts about the estimates and the availability of more accurate data about actual disputes filed. The SEC alleged that the $16 million adjustment “was not updated to reflect the more accurate and up-to-date data reflected in the later calculation,” nor did GTT provide “meaningful disclosure” regarding the adjustment, such as the potential material impact of the known uncertainties associated with the adjustment as required under Reg S-K, Item 303. According to the Order, the effect of the adjustment was to increase 2019 operating income by approximately 15% and decrease net loss before income taxes by approximately 13%. In Q1 of 2020, the SEC charged, GTT made similar unsupported adjustments of $19 million relating to a reassessment of the bulk disputes, following an increase in the estimated win rate without a reasonable basis of support. According to the Order, the $19 million adjustment in Q1 increased GTT’s operating income by almost 200% and decreased net loss before income taxes by 18%.
Finally, in December 2020, GTT filed a Form 8-K disclosing that its financial statements for the past three years and for Q1 of 2020 should not be relied on and that there were potential issues with internal control over financial reporting and disclosure controls and procedures. The company reported that it intended to restate its financials and expected to report a material weakness in ICFR and ineffective DCP. GTT also commenced an internal investigation related to the recording and reporting of COR.
After a year of attempts to correct its filings and tens of millions of dollars, GTT ultimately threw in the towel “due in part to the complexity of reconciling the two operational systems that were producing inconsistent information relevant to the calculation of COR.” GTT filed for bankruptcy and, upon emerging at the end of 2022 as a private company owned by certain of its former creditors, GTT was able to turn the page and use “Fresh-Start Reporting.”
Violations. The SEC charged that GTT violated Sections 17(a)(2) and 17(a)(3) of the Securities Act, which does not require scienter, as well as Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, 13a-13, and 12b-20 thereunder, as a result of materially misleading statements in an S-8 and in its periodic reports, respectively. The SEC concluded that reasonable investors would have considered the misleading statements and omissions important in making investment decisions about GTT’s securities during the relevant period. In addition, the SEC charged that GTT violated Exchange Act Sections 13(b)(2)(A) (books and records) and 13(b)(2)(B) (internal accounting controls) and Rule 13a-15(a), which requires public companies to maintain ICFR and DCP. In light of GTT’s prompt self-reporting to the SEC (even before GTT had reached final conclusions), substantial cooperation and affirmative remedial measures, including “attempting to rebuild its COR accounts, replacing certain members of management, its board of directors, and its auditor, and overhauling its accounting function, including its policies and procedures relating to COR,” the SEC ordered GTT to cease and desist from committing these violations in the future, but did not impose a civil penalty.