What’s Channel-Stuffing and Is It a Crime?

Channel-stuffing is a means of inflating a company’s revenues or sales immediately prior to a reporting period, such as the end of a fiscal quarter or the fiscal year.  It’s done to make it appear that the company’s financial performance is healthier than, in fact, it is.

In its most simple form, the company sends retailers and distributors in its distribution channel more products than those retailers would ordinarily purchase from the company or be able to sell to the public during a given period.  The company then books those as sales in the current quarter or year. 

The practice can have a detrimental impact on sales in the future quarters, however.  Because the retailers and distributors could not sell the excess product in the quarter in which they received it, the retailers will either return the product or sell it in a future quarter, diminishing the company’s sales and revenues in those quarters.  So, although channel-stuffing can help hit sales or earnings goals in the short term, unless future sales can keep up with the pace of the stuffing, the practice eventually undermines financial goals in future quarters.

No federal law specifically criminalizes channel-stuffing, and there may be legitimate reasons for a company to achieve sales during an earlier period.  But where a company provides excess supply to create a misleading impression about its sales or financial health, the practice is fraudulent and a form of improper revenue recognition.

Such conduct can be prosecuted under any number of statutes, including statutes that criminalize mail fraud, wire fraud, and accounting fraud.  If the company is public, a prosecutor can also bring charges for securities fraud, which criminalizes deceptive practices – such as making false, public statements about the company’s finances – that affect the public’s investment decisions.  A company engaging in channel-stuffing may also be subject to private shareholder actions for violation of the securities laws.  The SEC may also bring civil enforcement actions.

Channel stuffing usually occurs when executives fear a company will not meet its earnings forecast.  It often starts with the belief that the next quarter will be better and things will work out.  However, for many, at some point, the music stops.  Companies have had to undergo massive restatements and senior executives have gone to prison as a result of what started as a “one-time fix” to hit a company’s projections.

Some notable examples of criminal cases that included allegations of channel stuffing are the prosecutions of executives from energy giant Enron, software company Autonomy, and pharmaceutical company Bristol Myers Squibb.

To learn more about corporate and executive criminal liability, follow us on LinkedIn.  “Brilliant lawyers with courtroom savvy” – Benchmark Litigation.  Copyright MoloLamken LLP 2018.

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