The SEC reported the Kraft Heinz accounting scandal in 2021 after it was observed that the company had been hiding trails of finances for the past seven years, in the report, the SEC recorded that the company’s internal control had engaged in improper accounting practices that later on led to misstatements as observed in their financial statements.
In particular, asset prices were overstated for 2016 and 2017, and the auditors misrepresented the actual costs of products sold. Focusing on the roles of the Chief Financial officer and the senior executives in the company, the SEC reported misconduct in manipulating cost savings and failure in correcting accounting errors submitted by the company’s auditor.
Kraft Heinz was charged with violating the federal security laws’ antifraud, reporting, and internal control provisions. The company paid a $62 million penalty to settle the charges and pledged to cease future malpractices and violations.
The legal liabilities to third parties vary as to whether they seek relief under common law or federal securities law. The third parties who relied on the financial statements and might have suffered losses may sue Kraft Heinz for fraud, misrepresentation, or breach of contract. To successfully raise the issue in a court of law, the third parties are required to show that Kraft made a misleading statement (Gabaldon &Theresa A, 2019), that the third party relied on the statement, and that it, in turn, led to damages and losses as a result.
The Security Act of 1933 and the Securities Exchange Act of 1934 antifraud provisions prohibit companies from making false or misleading statements or omitting material information concerning the sale of securities (Gabaldon &Theresa A, 2019). The third parties can therefore bring a claim under federal securities law by showing that an omission or misleading statement was made by Heinz, ultimately causing damages on their end a result.
Some third parties might have been involved in the scandal or presented with the audit report but ignored the misstatements. Such cases should not be considered because the party was aware of what was happening and did not report the misconducts they observed. Suppose Kraft made each third party aware, and there is proof that he presented the audit report as it was, with no omissions or misleading statements. In that case, the case rests because the losses incurred are now out of their ignorance or indirect involvement.
The Generally accepted auditing standards (GAAS) are set to maintain consistency and accuracy in companies’ financial reports; hence these guidelines keep auditors on their toes. In the standards or reporting (Tuovila, 2020), if the auditor determines that informative disclosures in the financial report are inaccurate, the auditor must state that in the auditor’s report.
In the Kraft Heinz scandal, Pelleissone, the chief operating officer and the auditor of the financial reports received numerous warning signs that illegal agreements with Kraft’s suppliers were manipulating expenses. However, instead of addressing these issues, he pressured the procurement team to change the reports to meet unimaginably high cost-saving targets.
Management is responsible for preparing financial reports and identifying misconduct according to the generally accepted accounting principles (GAAP). Senior officials, including the CFO in the Kraft Heinz SEC scandal, were involved in the misconduct and manipulation of expenses to meet specific cost-saving estimates. The auditor’s role is to give an opinion on the fairness of financial statements presented and to identify and report any inaccuracies observed.
The auditor is primarily supposed to analyze the effectiveness of the company’s internal control over financial reporting and record any weaknesses of those controls to the management and the audit team (Tuovila, 2020). Management should have held the more significant burden because they are in charge of all finances and intentionally manipulated the figures to hide their malicious acts. The auditor should have recorded the weaknesses observed, which is a requirement of the GAAS. The auditor has no control over what happens in the top-level management.
The auditor must maintain professional skepticism when evaluating the evidence the management provides. However, it is still being determined if Pelleissone was part of the company’s top management ploy to mess with cost figures to benefit from it. However, if the auditor was unaware, he should not carry the weight inflicted by the management. The auditor holds no power in supplies and finances and might have reported the inconsistencies to the management, which has no impact if they want to bury the evidence of malpractice.
Some SOX sanctions include civil penalties imposed on public companies, their directors, and auditors for violating securities law, including accounting irregularities, by issuing fines or criminal penalties that can lead to imprisonment of up to 25 years (Chang et al., 2021). In some cases, the SOX can authorize suspension of license or revocation of registration penalties.
PCAOB should impose civil penalties on the Heinz management team and suspend the license of their audit firm PriceWaterHouse. The civil penalties should include fines and disgorgement of profits depending on the severity of the violations. The company’s internal control on financial reporting should also be reviewed, and changes made where necessary to prevent future misconduct.
Since the accounting irregularities might have been due to a poor financial decision made by the management years back, a criminal penalty is quite harsh. The company is a well-established brand with guaranteed profits. It is, therefore, better to keep the company up and running and impose a fine and disgorgements of profits for a specified period.
In conclusion, companies must maintain adequate financial reports to evade risks associated with accounting irregularities. Company executives should act with integrity to ensure that the financial audits are accurate and transparent.
References
SEC. “SEC.gov | SEC Charges the Kraft Heinz Company and Two Former Executives for Engaging in Years-Long Accounting Scheme.” Www.sec.gov, 3 Sept. 2021, www.sec.gov/news/press-release/2021-174.
Tuovila, Alicia. “Generally Accepted Auditing Standards (GAAS).” Investopedia, 11 Nov. 2020, www.investopedia.com/terms/g/gaas.asp#:~:text=Generally%20accepted%20auditing%20standards%20(GAAS)%20are%20a%20set%20of%20systematic.
Chang, Jui-Chin, Huey-Lian Sun, and Alex P. Tang. “Effect of SEC enforcement actions on forced turnover of executives: Evidence associated with SOX provisions.” International Review of Economics & Finance 76 (2021): 277-287.
Richardson, Grant, Ivan Obaydin, and Chelsea Liu. “The effect of accounting fraud on future stock price crash risk.” Economic Modelling 117 2022: 106072.
Gabaldon, Theresa A. “Equity, punishment, and the company you keep: discerning a disgorgement remedy under the federal securities laws.” Cornell L. Rev. 105 (2019): 1611.
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