Diageo to pay $5M for disclosure failures

According to the SEC’s order, in 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.” Specifically, during those periods, sales and finance department employees at Diageo’s largest and most profitable subsidiary, Diageo North America, pressured third-party distributors to buy products in excess of what distributors needed to fulfill market demand and in the face of declining overall demand for spirits.

As a result, North American distributors held substantial unneeded inventory. “The continued selling over demand was unsustainable, because it was likely that distributors would purchase less product in future periods,” the SEC order stated. “Diageo’s periodic filings did not disclose these known trends and uncertainties to investors.”

The overshipments of certain products to counteract declining market conditions and meet performance targets allowed Diageo to report higher growth in two of its key performance indicators—organic net sales growth and organic operating profit growth—financial metrics closely followed by analysts and investors, the SEC order stated. Thus, investors were misled to believe Diageo and Diageo North America could achieve growth in these areas through normal customer demand for Diageo’s products.

By FY2015, certain distributors began pushing back on orders. In response, Diageo North America designed and implemented—and Diageo approved—a plan to reduce inventory levels over a period of years, “principally through a reduction in shipments to distributors, a process known as destocking,” the SEC order stated.

Insufficient procedures

According to the SEC, Diageo lacked adequate procedures resulting in the disclosure failures. Specifically, Diageo’s Filings Assurance Committee (FAC) was responsible for ensuring the accuracy of the company’s financial disclosures. “The FAC reports in fiscal 2014 and fiscal 2015, which were also reviewed by management, reflected that DNA’s distributors were significantly increasing their inventories, resulting in significant additional net sales and operating profit,” the SEC order stated.

However, Diageo lacked sufficient procedures to consider whether the overshipments or the distributor inventory builds were trends or uncertainties that needed to be disclosed in the first place. Specifically, the SEC order states, Diageo did not disclose overshipments versus demand and the resulting distributor inventory levels, the positive impact those trends had on organic net sales and organic profit growth, the negative impact they were reasonably likely to have on future sales, and the fact they caused Diageo’s and Diageo North America’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 financial performance, the SEC said.

The SEC’s order finds Diageo violated the anti-fraud 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. Diageo did not admit or deny the findings in the SEC’s order.

In a brief statement, the company said that it is “pleased to have resolved this legacy matter, which relates back to fiscal years 2014 and 2015. Diageo regularly reviews and refines its policies and procedures and is committed to maintaining a robust and transparent disclosure process.”