HP Securities Enforcement Case: Paying Distributors to Take More Toner

In the HP securities enforcement case, HP Inc. agreed to pay a $6 million civil penalty to settle Securities and Exchange Commission charges over undisclosed printing-supplies sales practices and misleading channel-inventory disclosures. The Commission described quarter-end discounts that filled warehouses with unwanted toner and an inventory measure that left downstream stock out. If you worked with those orders, discounts or inventory reports, you may recognize what the public explanation missed.

The Securities and Exchange Commission announced the settlement on September 30, 2020. This page follows the Commission’s account of HP’s sales targets, distribution chain and disclosure failures, while our page on revenue recognition and premature sales compares how companies move orders between quarters and explain the resulting growth.

HP’s Printing-Supplies Targets Reached Into the Next Quarter

According to the Securities and Exchange Commission’s settled administrative order, HP’s regional managers began using increased quarter-end discounts in early 2015 to pull printing-supplies orders forward. Ink and toner belonged to the Supplies business within HP’s Printing segment. The order describes that business as a major source of profit and cash flow even as printing revenue declined, making supplies budgets especially important after Hewlett-Packard’s November 1, 2015 split.

The order describes a push model: HP sold to Tier 1 distributors, which sold to Tier 2 resellers farther down the chain. HP used marketing spending and discounts, called contra dollars, to move supplies toward end users. According to the order, HP recognized revenue on the initial sale to a distributor. A distributor could therefore take delivery and generate revenue for HP while the supplies still had other warehouses to pass through before reaching a printer owner.

In the Commission’s account, weekly flash reports showed regional managers how expected results compared with their budgets. As gaps emerged near quarter end, managers offered additional discounts to persuade distributors to order earlier than planned. The order says this trained the channel to expect better discounts in the final month, weakening sales earlier in the quarter and reducing the margin on accelerated orders.

The order quotes a regional general manager explaining the warehouse consequence. The manager’s words connect the unwanted inventory directly to the financial target:

HP’s Regional Discounts Became Other Regions’ Price Problem

The Securities and Exchange Commission’s order describes gray marketing, known regionally as A-Business, from early 2015 through June 2016. Managers in HP’s Asia Pacific and Japan region sold to resellers and brokers expected to move supplies outside their authorized territories. The order says HP policy and distributor contracts prohibited those sales, yet managers used them to fill gaps against targets, with goods moving through a network of firms into the Middle East.

The order says some discounts exceeded forty percent, while discounts for local distributors were in the teens. In its account, the practice became part of regional budgeting, and buyers demanded still better prices to accept additional inventory.

According to the Commission, supplies appeared in European and African markets, taking sales from local HP distributors and forcing price reductions there. Some discounted goods then reached the Americas, adding to inventory pressure. In that account, one region could meet its sales target while another inherited the price cut.

HP’s Channel Inventory Measure Left Out the Reseller

The Securities and Exchange Commission said HP’s weeks-of-supply measure counted Tier 1 distributor inventory but omitted stock farther down the chain. The order describes WOS as a comparison of that inventory with an average of recent sales. It says HP told investors on earnings calls whether inventory was within or above its internal target range without explaining the measure’s limited reach.

In the order’s account, that omission changed what it meant to meet the target. HP managers gave distributors additional discounts to sell supplies onward to resellers. This reduced the measured inventory without reducing total stock in the channel unless more supplies reached end users. It also created room for HP to sell more supplies to the direct distributors while staying under the inventory ceiling.

The Commission described in-and-out sales in which supplies moved into a direct distributor and immediately onward to a reseller. Managers could count the revenue without adding to the measured stock, even though the order says the transactions followed HP’s budget needs rather than end-user demand. The warehouses filled. The measure kept making room.

HP also lacked complete inventory data from downstream resellers, according to the order. It estimated their inventory after quarter end using incomplete information. For a distributor or reseller, the stock sitting on the shelves could tell a very different story from the range discussed on the earnings call.

HP’s Margin Explanation Left Out Its Own Discounts

The Securities and Exchange Commission said HP attributed declining gross margins to competitive pricing and currency effects while omitting the impact of accelerated orders and discounted cross-territory sales. The order identifies omissions in HP’s annual and quarterly reports and earnings calls. By its account, investors received explanations for weaker margins that left out the sales practices contributing to them.

The order describes a gap in the disclosure process too. HP lacked company-wide controls over regional discounts and sufficient interaction with operational employees who could have recognized the missing trends. The order says the officers responsible for public disclosures learned of the practices while HP was planning a change in its sales model. In that account, the people handling transactions knew things the disclosure process was not bringing forward in time.

On June 21, 2016, HP announced a move toward a model based on end-user demand and a reduction in channel inventory. According to the order, HP timed the change to coincide with a software-asset divestiture to lessen the impact on operating profit.

The Commission’s announcement says the inventory reduction cut net revenue by approximately $450 million during the third and fourth quarters of 2016. Its order says HP’s stock dropped nearly 6% after the announcement, eliminating more than $1 billion of market capitalization. We see a civil penalty dwarfed by the revenue reduction and the loss of stock-market value.

The Records Connect the Discount to the Public Number

An insider can connect the order a distributor accepted, the incentive that changed its timing and the explanation investors received. We examine those connections through the business records behind the reported results. HP’s case gives that comparison a specific shape:

• Order timing and forecasts. Requested delivery dates, revisions and weekly budget comparisons can show which sales moved forward and which target they filled.
• Discounts and destinations. Discount approvals, distributor territory terms and shipment records can connect an unusually cheap sale with the market where the supplies appeared.
• Inventory and the reported range. Distributor and reseller stock reports can show what remained unsold beyond the inventory measure described to investors.
• Operations and disclosure. Regional presentations, management communications and report drafts can connect what employees knew about margins and stock with the explanations in earnings calls and filings.

A 2019 literature review in Risk Governance and Control: Financial Markets & Institutions, Accounting Fraud: A Literature Review, identifies performance-linked compensation and pressure to meet internal goals and external expectations among motives for manipulating accounts. For the HP sales practices described by the SEC, we follow the targets through the discounts, inventory and disclosures.

Under Armour Also Pulled Future Orders Into Current Results

In its Under Armour order, the Securities and Exchange Commission described customer orders pulled into earlier quarters and a misleading explanation of revenue growth. The agency said the company failed to disclose the resulting uncertainty about future revenue. In the agency’s account, actual customer orders supplied the current result, while the explanation left out what moving those orders meant for later quarters.

HP adds the distribution problem to that pattern. According to its order, discounted sales increased stock beyond the part of the channel measured publicly and put pressure on prices elsewhere. Someone who knows the resellers’ inventory can explain a weakness that a comparison of quarterly sales alone would miss.

What a Printing-Supplies Insider Can Add

A sales employee may know why the discount grew, a reseller may know how much toner remained unsold, and a finance employee may know which inventory reports reached management. We assess how those accounts fit together when bringing securities fraud concerns to the SEC. Your knowledge of the commercial decision can make a public disclosure testable.

A study in the Journal of Forensic & Investigative Accounting, The Significance of Whistleblowing as an Anti-Fraud Measure, examined occupational-fraud cases. Its 2018 analysis found that whistleblowers detected 35.9% of the 4,943 cases with complete detection data, compared with 21.4% detected through internal controls.

Eligible SEC whistleblowers can share an award of 10% to 30% of qualifying sanctions collected when the action involves more than $1 million in monetary sanctions. If your information also concerns false claims for government money, that brings a separate whistleblower program into the discussion. A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. We work through how your information connects to the misconduct and the available whistleblower program with you.

You Know Where the Toner Went

If you saw discounts move orders, shift stock or hide a weakening sales channel, tell our whistleblower experts what happened inside the business. We work beside you to build the case around those commercial decisions and bring in SEC whistleblower lawyers who understand sales incentives and public-company disclosures. From the first conversation through the case, we make your knowledge of the business central to the work.