February 28, 2005

Does Sarbanes-Oxley Mean More Whistles Will Be Blown?

In the unlikely case you haven't heard, we'll pass on that Office Max is the latest (but not the last) retailer to be hit by a trade promotion accounting scandal. Initial reports, in January, were that the CFO had resigned and four employees fired after discrepancies were found concerning $3.3 million in falsely documented claims against a supplier. Last week, the Chicago Tribune reported that the CEO had resigned, two more employees had been fired, that the overstatements of income (not clear if all were related to claims) amounted to $4-6 million, and that some such items had been recorded in the wrong quarters -- which will result in restatements.

All of this is very unfortunate for Office Max and the folks involved, but pretty ho-hum for the rest of us. There's nothing very new here. We all know that many major retailers don't document their claims, or submit false/meaningless documentation, and all of us have long assumed that many claims aren't documented because there's nothing to document -- there was no performance.

But, despite that, there is a story here, or even a couple of related stories. One is that a supplier complained to a major customer about bad documentation, and the other is that the customer actually admitted to wrong-doing.

Suppliers have been confronted by documentation-phobic resellers for the past twenty years or so -- ever since the FTC stopped enforcing the Robinson-Patman Act (documentation is required under FTC's Guide 12):

The seller should take reasonable precautions to see that the services the seller is paying for are furnished and that the seller is not overpaying for them. The customer should expend the allowance solely for the purpose for which it was given. If the seller knows or should know that what the seller is paying for or furnishing is not being properly used by some customers, the improper payments or services should be discontinued.

In recent years, most suppliers have not even bothered to complain about documentation. On the rare occasions when they did say something, the response would be along the lines of, "Sorry, we don't have the documentation, but we assure you we did the promotion, so of course you'll pay the claim -- in the spirit of partnership." And the supplier paid the claim.

But that didn't happen this time. The supplier complained. And Office Max admitted there was a problem and returned the money (or cancelled the claim -- it isn't clear at what point the supplier lodged the complaint).

What happened? Why are both supplier and customer acting totally different than they have in the past?

Sarbanes-Oxley happened.

A supplier can no longer ignore gross violations of their trade promotion program rules, however dearly they care about "partnership". Most CFOs, not surprisingly, care more about not going to jail than they do about maintaining channel relationships. So, when they find a claim that is poorly documented, or have questions about the validity of the documentation, they're going to bounce it back to the customer.

And the customer can't laugh off such complaints any more, because their CFO is no more likely to want to do hard time. It's reasonable to speculate that penalties may be relatively light, at least at first, for Sarbox violations that result from poor systems and lack of knowledge, but where a company knows that violations are occurring (as, for example, where it has been brought to their attention by a supplier) they must act or the hammer will presumably come down hard.

Power has shifted - perhaps only slightly - back from the customer to the supplier. More importantly, priorities have changed, from maintaining channel relationships to maintaining financial integrity. It may mean that more suppliers blow the whistle.

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