SEC Enforcement Action Targets Unsupported Financial Projections

On August 7, 2018, the SEC brought a settled cease-and-desist proceeding against Ribbon Communications Inc., the successor to Sonus Networks, Inc., and two of its executives for issuing quarterly guidance that was not reasonably based on the available facts.

In October 2014, Sonus announced that it expected to generate $74 million of revenue in the first quarter of 2015. Sonus reaffirmed this guidance on January 8, 2015 and again on February 18, 2015. Seven days before the end of the first quarter, Sonus dramatically reduced its guidance to a range of $47 million to $50 million, after which its stock price fell by more than 33%.

The SEC found the two reaffirmations of the first quarter guidance to be materially misleading because Sonus ignored red flags indicating that it could not reasonably expect to achieve its revenue estimate. The SEC focused on the fact that, in the fourth quarter of 2014, Sonus had cannibalized sales from its first quarter pipeline in order to meet its fourth quarter goals, directly reducing the revenue it could reasonably expect to earn in the first quarter. The SEC also pointed out that Sonus started the first quarter with a substantially lower backlog than in prior periods, that its own “bottom-up” sales forecast was millions short of the revenue estimate and that efforts to increase backlog and cannibalize sales from the second quarter pipeline were not succeeding. The SEC was clearly bothered by management’s efforts, catalogued in internal e-mail, to force the sales team to reclassify uncommitted or speculative orders as “committed” for the first quarter, contrary to Sonus’s own guidelines. The SEC’s order noted that most of the reclassified orders did not in fact close in the first quarter. Ultimately, the SEC determined that Sonus and the two executives knew or should have known that the first quarter guidance of $74 million was materially misleading.

In announcing the settlement, the SEC’s Division of Enforcement stated: “The investing community expects that when companies choose to provide public financial projections, there is a reasonable basis underpinning those projections.  When a company ignores red flags or takes steps to make public financial projections inaccurate we will take appropriate action.”

To settle the proceeding, Ribbon agreed to pay a civil money penalty of $1.9 million. Sonus’s former CFO settled for $30,000 and Sonus’s Vice President of Global Sales settled for $40,000.

This proceeding should serve as a stern reminder to public companies that, when issuing or affirming earnings guidance or other forward-looking predictions, they must take into account all available information, including unfavorable developments. Saying what you think your investors want to hear, despite red flags to the contrary, carries a significant risk of a future visit from the Enforcement Division.

As another example, Elon Musk has drawn the attention of the SEC with his recent tweet that he may take Tesla private and has “secured” funding. A Wall Street Journal article notes that the SEC is looking into whether Musk had a factual basis for the tweet. Time will tell whether he did.

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