New York Securities Lawyer Blog
On September 27, 2016, the Securities and Exchange Commission (“SEC”) filed a complaint against oil services company Weatherford International PLC (“Weatherford”), consequently garnering a $140 million settlement related to fraudulent income tax accounting (the “Complaint”). According to the Complaint, Weatherford issued false financial statements between 2007-2012 inflating earnings by more than $900 million. Weatherford misrepresented both its earnings per share (“EPS”), and effective tax rate (“ETR”), and created a misperception for investors that a unique tax structure had been designed which provided it with a superior international tax avoidance strategy, when no such advantages existed. James Hudgins (“Hudgins”), Weatherford’s Vice President of Tax and Darryl Kitay (“Kitay”), Weatherford’s Tax Manager (collectively the “Defendants”) have agreed to settle charges that they orchestrated this fraud. Weatherford’s market cap is currently $5.04 billion, with the $140 million fine representing 2.7% of total valuation.
Weathorford is charged with: violation of Securities Act Section 17(a) and the Securities and Exchange Act of 1934 (the “Exchange Act”) Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B), and Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. Defendant Hudgins is charged with: (i) willfully violating Securities Act Section 17(a), Exchange Act Sections 10(b), and 13(b)(5) and Rules 10b-5(a) and (c), 13b2-1 and 13b2-2 disseminated thereunder; (ii) orchestrating Weatherford’s violations of Securities Act Section 17(a), Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and (B), and Rules 10b-5, 12b-20, 13a-1, 13a-11, and 13a-13 promulgated thereunder; and (iii) willfully violating federal securities laws pursuant to Section 4C of the Exchange Act and Rule 102(e)(1)(iii) of the Commission’s Rules of Practice. Defendant Kitay, due to his fraudulent conduct, faces charges of: (i) willfully violating Securities Act Section 17(a), Exchange Act Sections 10(b) and 13(b)(5), and Rules 10b-5(a) and (c), 13b2-1 promulgated thereunder; (ii) instigating Weatherford’s violations of Securities Act Section 17(a), Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and (B), and Rules 10b-5, 12b-20, 13a-1, 13a- 11, and 13a-13 promulgated thereunder; and (iii) willfully violating the federal securities laws pursuant to Section 4C of the Exchange Act and Rule 102(e)(1)(iii) of the Commission’s Rules of Practice.
Weatherford was formed in 1998 with the merger of two companies, and immediately embarked on a strategy of aggressive expansion. This directive was achieved largely through hundreds of acquisitions of smaller natural gas equipment and service providers, purchases that Weatherford financed by issuing corporate bonds. The SEC alleges that this unchecked growth was largely responsible for the lack of effective internal controls governing income tax accounting. In 2002, Weatherford completed an inversion to become incorporated in Bermuda, in order to be headquartered in a place of 0% tax jurisdiction. From 2003 through 2006, Weatherford continued to embark on ETR reduction strategies through tax hybridization schemes, including shifting debt assets to high tax jurisdictions such as the US and Canada, and equity assets to low or zero tax jurisdictions. These strategies reduced Weatherford’s ETR from 36.3% in 2001 to 25.9% in 2006. Each percentage point reduction in Weatherford’s ETR translated to an approximately $0.02 to $0.03 gain in Weatherford’s EPS, giving the company more latitude to issue debt and make more acquisitions to increase revenue.
In 2006, Weatherford’s drift away from Generally Accepted Accounting Practices (“GAAP”) began with the departure of the Chief Accounting Officer (“CFO”) who was a Certified Public Accountant (“CPA”) to whom Hudgins reported. The CFO who replaced him possessed a law degree rather than a CPA, and while well versed with mergers and acquisitions was not familiar with tax disclosures. With this shift, Weatherford’s tax department became focused entirely on achieving comparable ETRs to their inverted competitors, and no longer reported directly to the accounting department or to any persons with sufficient understanding of whether Weatherford’s tax strategy adhered to GAAP standards. This change led to rapidly reduced ETRs concocted through deceptive accounting practices, with Weatherford’s 2008 and 2009 ETRs at 17.1% and 6.5%, respectively.
These deceptive accounting practices were constructed as follows: Hudgins and Kitay made, or directed others in the tax department to make, post-closing line item adjustments to accounting data. The Defendants did not inform the accounting department that they were changing Weatherford tax data, and did not provide any back up evidence to support the new numbers they “plugged in.” They obscured these unwarranted adjustments within a tax provision labeled “dividend exclusions,” ultimately creating an accumulated $461 million phantom income tax during the four years this conduct went undetected. According to the complaint, Hudgins and Kitay essentially made a false receivable from the Internal Revenue Service (“IRS”) of $461 million, under the pretext of an abnormally large anticipated refund. To clarify, Weathorford does not “owe” the IRS any money as Hudgins and Kitay paid required tax bills in full. What the Defendants are alleged to have done is make it appear as if they had paid less taxes than they actually did through creating phantom future reimbursements, thereby reducing ETR and boosting EPS.
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