Diageo fined $5 million over alleged disclosure lapses

Alcohol company Diageo has agreed to pay a $5 million penalty to settle allegations that it failed to make necessary disclosures following efforts by its North American subsidiary to counteract weak market conditions.

Diageo, which is listed on both the NYSE and London Stock Exchange, owns brands including Johnnie Walker, Crown Royal, J&B, Buchanan’s and Windsor whiskies, Smirnoff, Cîroc and Ketel One vodkas, Captain Morgan, Baileys, Don Julio, Tanqueray and Guinness. It is headquartered in London and operates its US operations through Diageo North America (DNA).

The SEC says in an administration action that in Diageo’s fiscal years 2014 and 2015, the company did not make required disclosures of ‘known trends and uncertainties,’ which meant that its periodic filings were ‘materially misleading to investors with respect to its financial results.’

During the periods at issue, employees at DNA - Diageo’s largest and most profitable subsidiary - pressured distributors to buy products beyond the prevailing demand to meet performance targets in a flagging market, according to the SEC.

As a result, the agency alleges, distributors in North America held substantial unneeded inventory, which was a known trend or uncertainty. The continued over-selling was unsustainable because it was likely that distributors would purchase less product in future periods, and Diageo’s periodic filings did not disclose these known trends and uncertainties to investors, the SEC says.

The DNA employees’ ‘over-shipping’ of certain products to counteract declining market conditions and to meet performance targets allowed Diageo to report higher growth in certain of its key performance indicators, according to the regulator. These indicators included organic net sales growth and organic operating profit growth, financial metrics closely followed by investors and analysts, the SEC says. DNA’s over-shipping was also a factor in causing Diageo or DNA to meet or surpass analysts’ expectations for these two metrics, it alleges.

According to the agency, by early fiscal 2015 certain distributors’ inventory positions had become unsustainable and they started to push back on orders. In response, the SEC alleges, DNA designed and implemented, and Diageo approved, a plan to reduce inventory levels. Under newly agreed-to contractual terms with certain distributors, DNA planned to correct the elevated inventories over a period of years, principally through a reduction in shipments to distributors, a process known as ‘destocking,’ the regulator says. 

Diageo did not disclose the known trends and uncertainties created by DNA’s over-shipping and elevated distributor inventory levels because it did not have capable procedures in place to consider whether these issues were trends or uncertainties that needed to be disclosed, according to the SEC. As a result, the agency says, Diageo failed to disclose significant known trends and uncertainties in its 2014 and 2015 Forms 20-F.

The SEC alleges that, in particular, Diageo did not disclose:

• DNA’s over-shipments versus demand and the resulting distributor inventory levels
• The positive impact those trends had on organic net sales and organic profit growth, and the negative impact they were reasonably likely to have on sales in the future
• The fact that they caused Diageo’s and DNA’s reported financial information to not be indicative of future operating results or financial condition.

These omissions also rendered misleading certain statements the company made about its and DNA’s financial performance, the SEC says.

‘Investors rely on public companies to make complete and accurate disclosures upon which they can base their investment decisions,’ Melissa Hodgman, an associate director in the SEC's division of enforcement, says in a statement. ‘Diageo pressured distributors to take more products than they needed, creating a misleading picture of the company's financial results and its ability to meet key performance indicators.’

The company settled the SEC action without admitting or denying wrongdoing. It says in a statement: ‘Diageo is pleased to have resolved this legacy matter, which relates back to fiscal years 2014 and 2015. Diageo regularly reviews and refines its policies and procedures and is committed to maintaining a robust and transparent disclosure process.’