UPS Fined $45M for Bad Goodwill Moves
The Securities and Exchange Commission has fined UPS $45 million for covering up a nearly $500 million goodwill impairment the company should have disclosed in a poorly performing business unit, until the company sprang the bad news on investors more than a year later — an astonishing lapse of internal control for such a large, sophisticated business.
The SEC announced the settlement Friday afternoon. Essentially, UPS concluded by late 2019 that its under-performing UPS Freight unit deserved an impairment of $494 million against the goodwill that unit carried. Then the company sat on that information as it tried to sell the unit and kept its gloomy assessment away from external valuation specialists, who ended up saying the unit was worth much more. Only at the start of 2021 did UPS finally break the bad news about UPS Freight to investors, saddling them with painful reductions in net income and stockholder equity.
“It is essential for companies to prepare reliable fair value estimates and impair goodwill when required,” the SEC said in a press release. “UPS fell short of these obligations, repeatedly ignoring its own well-founded sale price estimates for Freight in favor of unreliable third-party valuations.”
UPS neither admitted nor denied the SEC’s findings, but did agree to hire an independent compliance consultant to review its policies and controls for goodwill assets and its disclosure controls. There’s also that $45 million penalty, which is chump change for a business as large as UPS ($90 billion in revenue last year) but still large enough to get the internal control community’s attention.
Anyway, goodwill impairment tests and the sale of subsidiary business units are standard fare in Corporate America, and SEC enforcement over tardy impairments are not unheard of. So let’s take a look at how UPS fumbled this transaction and what lessons other financial reporting teams can learn.
Sitting on Bad Goodwill News
Our tale begins in mid-2019, when (as described in the SEC settlement order) UPS’ corporate strategy group began considering whether to sell the company’s UPS Freight business unit. The company’s in-house analysts soon concluded that UPS Freight would probably sell for $350 million to $650 million.
Alas, that estimate was far less than the $1.4 billion valuation that UPS was carrying on the books for UPS Freight. Even selling at $650 million would require UPS to write off essentially all of the goodwill associated with UPS Freight — nearly $500 million, an amount that would lead to a material cut in net income and go over like a fart in church with investors.
UPS management decided not to sell UPS Freight at that time, but U.S. accounting rules meant the company couldn’t turn a blind eye to the conclusions from its corporate strategy team about needing to impair those goodwill assets. UPS should have factored those conclusions in the annual testing of goodwill assets that all companies are required to perform.
Well, that didn’t happen. Instead, UPS hired an external valuation consultant to provide an independent estimate of what UPS Freight would be worth — and then let the consultant work from a set of flawed assumptions about how a sale would proceed and kept that grim in-house analysis from him.
Then, when the consultant concluded that UPS Freight was worth $2 billion — more than three times as much as the $650 million estimate that UPS’ own in-house team had figured — UPS used that consultant’s egregiously high estimate as proof that, nope, we don’t need to declare a goodwill impairment after all.
UPS finally decided to sell the UPS Freight unit in mid-2020, and in October of that year found a buyer willing to purchase the unit for $800 million. On Nov. 3, one day after UPS filed its quarterly report, management informed the board about the sale and said UPS would need to write off $494 million in goodwill.
What’s wrong with all that is this: management had a signed term sheet in October valuing the business at $800 million, and knew a big goodwill impairment was looming. Then, when UPS had to test its goodwill assets again later in that same quarter, it ignored the facts in the term sheet and still relied on that external consultant’s original, overvalued estimate. So for a second straight year, UPS again concluded that no impairment was necessary and kept carrying UPS Freight on the books valued at $1.3 billion.
Only when the sale was finally announced in January 2021 did UPS also, finally, disclose a goodwill impairment charge of $494 million. That charge reduced UPS’s 2020 operating income by 6 percent, net income by 20 percent, and stockholder equity by 32 percent.
By keeping those goodwill troubles hidden for more than a year, the SEC said, UPS misled investors about the true value of the business. And here we are.
Root Cause Analysis
So how did all this happen? The SEC order dwells on the role of an unidentified “then-senior accountant” at UPS, and does not portray her in a flattering light.
According to the SEC, this senior accountant knew all about the original in-house estimate for UPS Freight that pegged the unit’s value at $350 million to $650 million. She also knew that the financial projections UPS provided to the external valuation consultant were based on faulty assumptions that real would-be buyers would never use. Plus, as head of the team that performed UPS’ annual goodwill impairment tests, this senior accountant knew that those tests should be based on assumptions that real would-be buyers would use.
In other words, this senior accountant had all the pieces in front of her to know that the true value of the UPS Freight unit was far below the $1.3 value UPS was carrying — and still chose to conduct impairment tests using assumptions nobody in the real world would use. That decision allowed UPS to avoid setting off its $494 million stink-bomb for 18 months and keep telling investors everything was fine.
To be honest, I wonder about this explanation. The behavior outlined in the SEC order would be a huge risk for a senior accountant to take. Indeed, as part of the settlement, UPS agreed to cooperate with the SEC in any other enforcement proceedings that might arise from this settlement, which makes me think this senior accountant needs an attorney, like, last week. Or perhaps others in the company somehow set up this accountant to be a scapegoat. We don’t know.
You also have to wonder about the flow of information at a company, to keep goodwill impairment testing procedures on track. One can certainly appreciate the need to keep sensitive information (like, say, the sale of an under-performing business unit) confidential, but an overly restrictive approach does your company no favors.
If one person can keep important information away from the impairment testing team, then that person needs to follow impeccable ethical standards. Alternatively, you need processes and information flows that rely on multiple people, to offset the risk that one single person (like a senior accountant) can withhold important information and cause a disclosure disaster — which seems to be what happened here.
If we were going to map this mess to the COSO framework for internal controls, the failures happened with Principles 14 (“The entity internally communicates information necessary to support the functioning of internal control”) and 15 (“The entity communicates with external parties regarding matters affecting internal control”). Don’t forget Principle 4, either: “The entity demonstrates a commitment to attract, develop, and retain competent individuals in alignment with objectives.”
Presumably the independent compliance consultant that UPS must hire as part of the settlement will look closely at all policies, procedures, and controls related to those three principles. Quite a painful lesson for UPS to learn.