Tuesday, the SEC announcement has settled charges against Baxter International Inc., its former treasurer and assistant treasurer, for misconduct related to improper intra-company foreign exchange trading that resulted in misreporting of the company’s net income. From at least 1995 to 2019, according to the SEC, Baxter translated transactions, assets and liabilities denominated in foreign currencies in its financial statements using its own “convention” – not in accordance with US GAAP. Then, beginning around 2009, the SEC accused Baxter of leveraging the convention to engineer a series of non-operating intra-company foreign exchange transactions “solely for the purpose of generating foreign currency accounting gains or avoiding accounting losses in foreign currency”. In the ordered against Baxter, the SEC found that the company violated the negligence-based anti-fraud provisions, public reporting, books and records, and internal accounting controls provisions of the federal securities laws and imposed a fine of 18 millions of dollars. In this ordered and that ordered, the SEC found that the company’s treasurer “took no steps to investigate how Baxter’s treasury department generated consistent earnings or whether the transactions that generated the earnings were authorized,” and that the assistant treasurer, working with others under his direction, was “primarily responsible for the execution of transactions.” The Treasurer and Assistant Treasurer were determined to have violated the negligence-based anti-fraud provisions of the federal securities laws and caused violations of public reporting and Baxter’s books and records.
As described in the orders, Baxter is a US-based healthcare products company that generates the majority of its revenue outside of the United States. Many of the company’s subsidiaries use various foreign currencies “because they manufacture and sell products globally and transact in foreign currencies.” Under applicable GAAP Accounting Standards Codification Topics, companies are required to initially measure and record foreign currency transactions in the company’s functional currency using the exchange rate at the date of the transaction. In addition, assets and liabilities denominated in foreign currencies should be revalued at the end of each reporting period using the exchange rate at that date. But, according to the orders, Baxter did not apply these GAAP ASCs. Instead, Baxter applied its own “FX convention”, under which “foreign currency transactions during a given month were initially measured using exchange rates from a specified date to the middle of the previous month, as opposed to the exchange rate at the date of the transaction In addition, assets and liabilities denominated in foreign currencies were then revalued at the end of each month using the exchange rates from a specified date around the middle of the current month, referred to as “Day T,” not the end of the reporting period.” Due to the FX convention, according to the orders, Baxter employees knew the exchange rates that s would apply to intra-company transactions from day T of a given month until the end of the month.
Around 2009, according to the orders, Baxter sought to more effectively manage the company’s foreign exchange exposure and reduce its use of third-party derivative contracts by instead managing “its currency exposures on a consolidated basis by offsetting cash positions”. To better control declared foreign exchange gains and losses. Baxter’s Treasury department has developed “FX transactions” – transactions designed solely to generate non-operating foreign exchange accounting gains or avoid foreign exchange accounting losses. Initially, the Treasury used “FX transactions to avoid losses caused by exchange rate fluctuations. Over time, this practice has evolved to proactively generate gains from exchange rate fluctuations. The FX trades, according to the SEC, consisted of a series of transactions involving capital distributions, currency swaps and offset loans designed to create a foreign exchange gain or avoid a loss in Baxter subsidiaries. After the end of the month, according to orders, the Treasury group would unwind currency trading and lending. Because they knew the exchange rates in advance, the SEC charged, Treasury staff were able to generate specific amounts of accounting gains or avoid specific amounts of accounting losses.
The SEC orders alleged that although the Treasurer was not involved in the development of FX transactions, “he realized that there were consistent gains generated by the Treasury Department down the line.” other (revenue) expenses, net”. However, he “never considered how the Treasury Department was able to consistently generate the gains, or whether the transactions that generated the gains were authorized.” According to the orders, since FX trades had taken place prior to his tenure as treasurer (which began in 2015), “he believed the trades had been pre-vetted and approved.” Misstatements of foreign exchange gains and losses during the Treasurer’s tenure would have been at least $245 million. Additionally, according to the SEC, the Assistant Treasurer, who executed the FX trades, believed they were authorized by senior Baxter officials, but he “negligently failed to realize that it was inappropriate to use Baxter’s FX agreement to execute FX transactions for the sole purpose of generating foreign exchange accounting gains or avoiding foreign exchange accounting losses.”
According to the orders, accounting gains generated (or losses avoided) from foreign exchange transactions were reported on the “other (income) expense, net” line of Baxter’s financial statements and were reflected in net income and Baxter EPS. From 2015 through the first two quarters of 2019, according to the SEC, Baxter reported foreign exchange gains totaling $286 million. The SEC accused the inappropriate FX trading of inflating the company’s net income and EPS, and that Baxter “should have discovered that the FX trading caused materially inaccurate financial results.” However, the SEC alleged that Baxter did not have adequate internal accounting controls over intra-company transactions to identify improper foreign exchange gains generated by FX transactions.
These practices, according to the SEC, came to light in 2019 when Baxter’s tax department questioned Treasury staff about the details of FX transactions. According to the orders, several months later, Baxter adopted a GAAP-compliant exchange rate agreement and announced an internal investigation, ultimately resulting in a restatement of its financial statements. In the restatement, Baxter reduced its total reported foreign exchange gains and losses from 2010 to the second quarter of 2019 by $517 million. In its 10-K for 2019, Baxter disclosed that it had a material weakness in its internal control over financial reporting related to the recognition of foreign exchange gains and losses: it did not have controls that would enable the company to quantify the difference between the foreign exchange gains and losses it reported using FX convention and those it would have reported using GAAP exchange rates, nor did it have adequate policies and controls to “approve and monitor intra-company transactions to prevent or detect FX transactions”.
Baxter was charged with fraud in violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act, periodic and current reporting violations under Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11 and 13a-13, violations of books and records under Section 13(b)(2)(A) of the Exchange Act, and failure to maintain an adequate system of internal accounting controls pursuant to Section 13(b)(2)(B) of the Exchange Act. None of these violations required a scientific finding. In addition to hiring a new treasurer and improving its processes, Baxter also clawed back bonuses paid to the CEO, CFO, treasurer ($192,000) and other executives in accordance with its clawback policy. executive compensation and SOX 304 clawback provisions and paid the SEC a civil penalty. of $18 million.
The Treasurer and Assistant Treasurer have been charged with fraud in violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act and causing the periodic and ongoing reporting violations of Baxter under Sections 13(a) of the Exchange. Act and Rules 13a-1, 13a-11 and 13a-13, and its books and records violates under Section 13(b)(2)(A). The Treasurer was ordered to pay a civil penalty of $125,000, and the Assistant Treasurer was ordered to pay restitution (related to bonus payments) and interest of approximately $90,000 and a civil penalty of $100,000 .
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