Is Michelle Stacy a shrewd insider, a psychic or just plain lucky?

In my last blog post I asked the following question about Green Mountain Coffee Roasters (NASDAQ: GMCR) Keurig Division President Michelle Stacy:

Is Michelle Stacy a shrewd insider, a psychic or just plain lucky? Perhaps the people who designed and administer her purported 10b5-1 trading plan are geniuses?

On February 14, 2011, Green Mountain Coffee stock opened for trading at $42.14 per share. At 11:00 AM Reuters reported:

Green Mountain Coffee Roasters Inc's (GMCR.O) shares fell as much as 4 percent after Starbucks Corp (SBUX.O) said it plans to announce a new product for the single-cup coffee market, a move that could threaten Green Mountain's dominance in the fast-growing sector.

The stock price of Green Mountain shares dropped to a low of $41.53 per share in intra-day trading.

At around 3:25 PM (Eastern) that afternoon, Green Mountain Coffee shares spiked up from just under $42 per share to $45 per share. See the Bloomberg chart below (times posted on chart are Central time):

Click on image to enlarge.

At around 3:34 PM (Eastern) that afternoon, Reuters citing an unnamed source reported:

Starbucks Corp (SBUX.O) and Green Mountain Coffee Roasters (GMCR.O) are in partnership negotiations, a source close to the talks told Reuters on Monday, sending Green Mountain shares surging.

On that same day, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $45.13 per share through her 10b5-1 trading plan. Green Mountain Coffee's shares did not trade above $45 per share until after 3:25 PM (Eastern) according to the above chart. Green Mountain Coffee shares closed at $46.35 per share.

On February 15, 2010, the market value of Green Mountain Coffee stock closed at $43.53 per share, a drop of $2.82 per share from the previous day's closing price of $46.35 per share.

Timing of Michelle Stacy’s other stock sales

On August 13, 2010, Michelle Stacy exercised 30,000 options at $6.20 per share and simultaneously sold those shares at $30.95 per share.

On September 13, 2010, exercised 5,000 options at $6.20 per share and simultaneously sold those shares at $35.20 per share.

On September 20, 2010, Green Mountain Coffee claimed that it was notified by the Securities and Exchange Commission (SEC) of an informal inquiry concerning its “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.” However, the company did not disclose news of the SEC inquiry to investors until seven days later.

On September 21, 2010, Michelle Stacy exercised 4,375 options at $6.20 per shares and simultaneously sold her shares at $37 per share. In addition, Stacy exercised another 625 options at $9.14 per share and simultaneously sold those shares at $37 per share.

After the market closed on September 28, 2010, Green Mountain Coffee finally disclosed news of the SEC inquiry to investors. In addition, the company disclosed that it discovered an "immaterial accounting error" involving its K-Cup margin percentages which resulted in a $7.6 million cumulative overstatement of pre-tax income in financial reports issued from 2007 to June 26, 2010. A significant amount of those accounting errors came from the Keurig segment which is headed by Michelle Stacy.

On September 29, 2010, the next trading day, Green Mountain Coffee stock dropped $5.95 per share to close at $31.06 per share as investors reacted to news of the SEC inquiry, a 16.1% drop in market value that day.

By October 11, 2010, the market value of Green Mountain Coffee’s shares dropped to $26.87 per share, far below the price per share that Stacy sold her stock on August 13 ($30.95), September 13 ($35.20), and September 21, 2010 ($37.00).

On October 21, 2010, I raised questions about the timing of Michelle Stacy's stock sales.

On October 28, 2010, Stacy belatedly filed amended Form 4 reports and claimed she established a Rule 10b5-1 trading plan on August 13, 2010. A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold. She amended certain SEC Form 4 filings for her stock sales on September 13 and September 21 to reflect her 10b5-1 trading plan. However, her sale of 30,000 shares on August 13 was not pursuant to a 10b5-1 trading plan. According to Stacy's amended SEC filings, her 10b5-1 trading plan only covered future stock transactions.

On November 5, 2010, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $35 per share.

On February 7, 2011, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $40.00 per share. In addition, she exercised another 5,561 options at $9.14 per share and simultaneously sold those shares at $40 per share.

On Thursday, March 10, 2011, Green Mountain announced a “strategic relationship” with Starbucks. In reaction to the news, the market value of Green Mountain Coffee common stock rose $21.07 per share to close at $61.71 per share, or a 46% increase from the prior day’s closing price. That same day, Michelle Stacy exercised 9,375 options at $6.20 per share and simultaneously sold them at $55.54 per share, $11.90 per share higher than the previous day's closing price per share.

Other Green Mountain insiders were not as fortunate as Michelle Stacy. MarketWatch reported:

Green Mountain insiders miss big option gain
Options priced after Green Mountain stock jumps 41% in single day

SAN FRANCISCO (MarketWatch) —March 10 was options day for insiders at Green Mountain Coffee Roasters. Too bad it was the day the stock hit a record high and the options are presently worthless.

Their latest batch of stock options were priced Thursday as Green Mountain(GMCR 58.86, -2.85, -4.62%)  shares ran up 41% on news the company had struck a deal for Starbucks (SBUX 36.56, -1.41, -3.71%)  to make coffee for its Keurig single-cup coffee brewers. Read Starbucks, Green Mountain brew K-Cup deal.

According to filings Friday afternoon with the Securities and Exchange Commission, eight directors were each granted 2,300 stock options at Thursday’s closing price of $61.71 a share — a record high on a split-adjusted basis. The previous day the stock had closed at $43.64.

From August 13, 2010 to March 10, 2011, Michelle Stacy made a gross profit of $2.689 million from exercising options and selling shares.

In the quarter ended December 25, 2010, Green Mountain Coffee's Keurig segment reported a $1.955 million loss before taxes.

Class-action lawsuit

The amended class-action complaint alleges that Green Mountain Coffee knew that the SEC was poking around as early May 2010 or three months before Michelle Stacy claims she adopted a 10b5-1 trading plan. See paragraphs 68, 69, 103, and 104). If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations.

Final comment

Every corporate insider should seek out who designed and administers Michelle Stacy's 10b5-1 trading plan and hopefully, they can be as lucky as she is. In any case, Stacy's got great timing!

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

Green Mountain Coffee Roasters: The Foul Aroma of Michelle Stacy's Stock Sales

On Thursday, March 10, 2011, Green Mountain Coffee Roasters (NASDAQ: GMCR) announced a “strategic relationship” with Starbucks (NASDAQ: SBUX). On that same day, Green Mountain Coffee granted stock options to certain insiders at its “Board of Directors meeting simultaneously following the Company’s Annual Meeting of Shareholders.” On Friday, MarketWatch reported:

Green Mountain insiders miss big option gain
Options priced after Green Mountain stock jumps 41% in single day

SAN FRANCISCO (MarketWatch) —March 10 was options day for insiders at Green Mountain Coffee Roasters. Too bad it was the day the stock hit a record high and the options are presently worthless.

Their latest batch of stock options were priced Thursday as Green Mountain(GMCR 58.86, -2.85, -4.62%)  shares ran up 41% on news the company had struck a deal for Starbucks (SBUX 36.56, -1.41, -3.71%)  to make coffee for its Keurig single-cup coffee brewers. Read Starbucks, Green Mountain brew K-Cup deal.

According to filings Friday afternoon with the Securities and Exchange Commission, eight directors were each granted 2,300 stock options at Thursday’s closing price of $61.71 a share — a record high on a split-adjusted basis. The previous day the stock had closed at $43.64.

Were all of Green Mountain Coffee’s insiders as unfortunate as the MarketWatch story implies? The answer is no. One insider, Michelle Stacy who is President of Green Mountain Coffee's Keurig Division seems to have made out like a bandit. She exercised 9,375 options at $6.20 per share and simultaneously sold them at $55.54 per share. Stacey sold her stock at $11.90 per share higher than the previous day's closing price. Sometimes I wonder, is Michelle Stacy a shrewd insider, a psychic, or just plain lucky?

Timing of Michelle Stacy’s stock sales

On August 13, 2010, Michelle Stacy exercised 30,000 options at $6.20 per share and simultaneously sold those shares at $30.95 per share. On September 13, 2010, exercised 5,000 options at $6.20 per share and simultaneously sold those shares at $35.20 per share. Seven days later, on September 20, 2010, Green Mountain Coffee claimed that it was notified by the Securities and Exchange Commission (SEC) of an informal inquiry concerning its “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.” However, the company did not disclose news of the SEC inquiry to investors until seven days later.

On September 21, 2010, Michelle Stacy exercised 4,375 options at $6.20 per shares and simultaneously sold her shares at $37 per share. In addition, Stacy exercised another 625 options at $9.14 per share and simultaneously sold those shares at $37 per share. Seven days later, after the market closed on September 28, 2010, Green Mountain Coffee finally disclosed news of the SEC inquiry to investors. In addition, the company disclosed that it discovered an "immaterial accounting error" involving its K-Cup margin percentages which resulted in a $7.6 million cumulative overstatement of pre-tax income in financial reports issued from 2007 to June 26, 2010.

Maybe seven is a lucky number for Michelle Stacy? On September 13, she sold 5,000 shares seven days before Green Mountain Coffee claims it received notice of an SEC on September 20. On September 21, she sold another 5,000 shares seven days before Green Mountain Coffee disclosed news of the SEC inquiry to investors on September 28. That same day, Green Mountain Coffee reported that it overstated pre-tax income by $7.6 million dollars.

On September 29, 2010, the next trading day, Green Mountain Coffee stock dropped $5.95 per share to close at $31.06 per share as investors reacted to news of the SEC inquiry, a 16.1% drop in market value that day. By October 11, 2011, the market value of Green Mountain Coffee’s shares dropped to $26.87 per share, far below the price per share that Stacy sold her stock on August 13 ($30.95), September 13 ($35.20), and September 21, 2010 ($37.00).

In a blog post dated October 21, 2010, I expressed my concern about the possibility of illegal insider trading by Michelle Stacy based on the timing of her stock sales. Seven days later, on October 28, 2010, Stacy belatedly filed amended Form 4 reports and claimed she established a Rule 10b5-1 trading plan on August 13, 2010. A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold. She amended certain SEC Form 4 filings for her stock sales on September 13 and September 21 to reflect her 10b5-1 trading plan. However, her sale of 30,000 shares on August 13 was not pursuant to a 10b5-1 trading plan. According to Stacy's amended SEC filings, her 10b5-1 trading plan only covered future stock transactions.

Eventually, Green Mountain Coffee’s stock price recovered from its low point of $26.87 per share on October 11, 2010 to close at $34.63 per share on November 5, 2010. On that same day, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $35 per share.

On February 7, 2011, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $40.00 per share. In addition, she exercised another 5,561 options at $9.14 per share and simultaneously sold those shares at $40 per share.

Seven days later, on February 14, 2011, Green Mountain Coffee stock opened for trading at $42.14 per share. At 11:00 AM Reuters reported:

Green Mountain Coffee Roasters Inc's (GMCR.O) shares fell as much as 4 percent after Starbucks Corp (SBUX.O) said it plans to announce a new product for the single-cup coffee market, a move that could threaten Green Mountain's dominance in the fast-growing sector.

The stock price of Green Mountain shares dropped to a low of $41.53 per share in intra-day trading.

Later that day, at around 3:34 PM, Reuters citing an unnamed source reported:

Starbucks Corp (SBUX.O) and Green Mountain Coffee Roasters (GMCR.O) are in partnership negotiations, a source close to the talks told Reuters on Monday, sending Green Mountain shares surging.

The Wall Street Journal reported:

Unusually fast movement – up or down 10% in less than five minutes – leads to a five-minute trading pause. This trading break is one of the fixes implemented after the Flash Crash last spring. In the case of Green Mountain, its shares shot to 47.88 from 41.81 – a 14% move in about five minutes.

[Snip]

Reuters reported in the afternoon that the two coffee companies are chatting about a possible partnership, which might have triggered a big enough stampede to get shorts covering positions in earnest.

On that same day, Michelle Stacy exercised 10,000 options at $6.20 per share and simultaneously sold her shares at $45.13 per share.

On February 15, 2011, the Associated Press reported:

Shares of Green Mountain Coffee Roasters Inc. slumped in early trading after coffee chain giant Starbucks Corp. announced a single-cup coffee deal with a rival company.

Market speculation that coffee chain giant Starbucks Corp. would soon announce a partnership with Green Mountain had jacked up the single-serve brewer maker's shares -- the stock jumped $2.89, or 6.7 percent, to $46.35 Monday and have risen about 48 percent in the past three months.

On February 15, 2010, the market value of Green Mountain Coffee stock eventually closed at $43.53 per share, a drop of $2.82 per share from the previous day's closing price of $46.35 per share. On the previous day, Michelle Stacy sold 10,000 Green Mountain Coffee shares at $45.13 share.

On Wednesday, March 9, 2011, Green Mountain Coffee shares closed at $43.64 per share. On Thursday, March 10, 2011, Green Mountain announced a “strategic relationship” with Starbucks. In reaction to the news, the market value of Green Mountain Coffee common stock rose $21.07 per share to close at $61.71 per share, or a 46% increase from the prior day’s closing price. That same day, Michelle Stacy exercised 9,375 options at $6.20 per share and simultaneously sold them at $55.54 per share, $11.90 per share higher than the previous day's closing price per share.

Class-action litigation alleges illegal insider trading

Is Michelle Stacy a shrewd insider, a psychic or just plain lucky? Perhaps the people who designed and administer her purported 10b5-1 trading plan are geniuses? Lawyers representing plaintiffs in a class-action lawsuit against Green Mountain Coffee don’t think so. They are alleging that Michelle Stacy and certain other insiders engaged in illegal insider trading.

According to amended class-action complaint (download here):

68. Moreover, although the September 28, 2010 Form 8-K indicates that, "[o]n September 20, 2010, the staff of the SEC's Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information," the above-noted former employee has stated that by no later than the first week of May 2010, he/she was contacted by Company employees who asked if he/she had been had been the whistleblower in an SEC investigation of GMCR.

69. Accordingly, Company employees contacted the confidential witness concerning an SEC investigation five months prior to the issuance of the September 28, 2010 Form 8-K, which disclosed that the SEC informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information on September 20, 2010. 

In other words, the amended class-action complaint alleges that Green Mountain Coffee knew that the SEC was poking around as early May 2010 or three months before Michelle Stacy claims she adopted a 10b5-1 trading plan. If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations.

The amended class-action complaint took issue with the timing of Michelle Stacy‘s stock sales and the timing of her 10b5-1 trading plan:

103. Prior to these sales, there had not been significant insider trading activity since June 2009. Not only did both division presidents sell the majority of their shares, but Stacy did so the day after the SEC's information request and one week before GMCR made the SEC inquiry public.

104. Even worse, in October 2010, Stacy amended her Form 4s for the August and September sales, claiming that she forgot to include in the original Form 4s that the sales were made pursuant to a Rule 10b5-1 trading plan adopted on August 13, 2010. Not only did the Company fail to inform the SEC of the plan on the day it was adopted, but it failed to disclose the plan when Stacy's Form 4 for the $928,500 sale was filed a mere four days after its adoption.

Michelle Stacy did not amend her Form 4 for her August 13 exercise and simultaneous sale of 30,000 shares of stock. She adopted her 10b5-1 trading plan that same day to cover her future sales of stock. That error in the class-action amended complaint aside, Michelle Stacy has a lot of explaining to do. A significant amount of Green Mountain Coffee's accounting errors which caused it to restate its financial reports resulted from material weaknesses in internal controls over financial reporting in the Keurig division headed by her. What did she know about financial reporting problems on August 13, 2010? If she knew nothing, was she incompetent or dumb?

Written by,

Sam E. Antar

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them as an independent whistleblower. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

Is Green Mountain Coffee Going to Get Roasted by its Exes?

Last week, lawyers representing investors filed an amended class-action lawsuit against Green Mountain Coffee Roasters (NASDAQ: GMCR) and members of its management containing new allegations of wrongdoing based on information:

…obtained from confidential witnesses, including former Green Mountain Coffee Roasters, Inc. ("GMCR" or the "Company") and M.Block & Sons, Inc. ("MBlock") employees…. [Emphasis added.]

Note: Download the amended class-action complaint here.

The three exes

In law enforcement circles, there is a term known as the “three exes” for ex-lovers, ex-employees, and ex-business associates. In many cases, such informants provide crucial information to law enforcement agencies that investigate and prosecute white-collar crime. In this case, the amended complaint is based on detailed first-hand accounts of alleged wrongdoing by the company obtained from several ex-employees and ex-business associates who are identified as "confidential" witnesses such as CW 1, CW2, and CW 3. One such ex-employee identified as "CW 6" is a former Vice President of Operations for Green Mountain Coffee.

The amended complaint identifies various alleged schemes employed by Green Mountain Coffee to deliberately violate Generally Accepted Accounting Principles (GAAP) and prematurely recognize income on the shipment of products to M. Block, its primary fulfillment vendor.

CNBC Senior Stock Commentator Herb Greenberg wrote in his blog that:

My take: I generally ignore class action lawsuits, but they're hard to dismiss out of hand when they include allegations from multiple former employees.

Is M. Block a "black box" entity used to inflate earnings?

The complaint effectively describes M. Block, in what is known in fraud investigation circles, as a "black box entity" used by fraudsters to play shell games with inventory and inflate income. Back in the day at Crazy Eddie, we took advantage of our cozy relationship with certain third party entities and effectively used them as "black box entities" to help us inflate our earnings.

For example, the amended complaint alleges that:

64. Information provided by former GMCR and MBlock employees described the companies' relationship as one where GMCR dictated their business dealings and being something other than on an arms-length basis.

[Snip]

66. A former regional sales manager for GMCR from late 2008 until late 2010 ("CW2") stated that anyone at the Company would acknowledge that MBlock was, in essence, a captive company and would do as GMCR instructed. CW2 indicated that his/her current employer is careful in its dealings with MBlock because it is aware of the close relationship between GMCR and MBlock.

One of the alleged schemes detailed in the amended complaint involves the shipment 150 truck loads of merchandise to M. Block to inflate revenues in the quarter ended December 26, 2009:

70. CW1 indicated that GMCR improperly recognized revenue on 150 truck loads of product that was shipped to MBlock during the quarter ended December 26, 2009. This former GMCR manager stated that he/she and other Company employees, including the Company's global transportation manager, were unable to locate the requisite paperwork, including purchase orders, material requisition orders, or product shipment authorizations, traditionally used by GMCR to validate the sale.

71. Specifically, CW1 indicated that because there was no order for those products, no payment was ever made on the 150-truckload shipment. In addition, the order was not listed on the Company's production forecast schedule and employees who worked under CW1 not only saw the trucks go out, but visited MBlock and saw its warehouses filled to the rafters with K-Cups. CW1, who estimated that the value the revenue recognized on the foregoing improperly recorded transaction to be between $7.5 and $15 million dollars, indicated the following GMCR executives were aware of the shipment: Vice President of Operations Jonathan Wettstein (who regularly provided updates to CEO Blanford), SBCU President McCreary and Vice President of Finance Tina Bissonette.

72. As a result of the foregoing, GMCR violated GAAP's criteria of revenue recognition, which provides that the conditions for revenue recognition ordinarily are met when the seller's price to the buyer is substantially fixed or determinable at the date of sale; the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; the buyer's obligation to the seller is not changed in the event of theft or physical destruction of the product; the buyer has economic substance apart from the seller; the seller does not have significant future performance obligations to the buyer; and the amount of future returns, if any, can be reasonably estimated. See, e.g., Accounting Standards Codification 605.

73. Consequently, GMCR violated its revenue recognition policy, as disclosed in the 2010 Form 10-K, when it prematurely recorded revenue on shipments of product to MBlock:

The Company recognizes revenue when the fulfillment entities ship the product based on the contractual shipping terms, which generally are upon product shipment, and when all other revenue recognition criteria are met. 

74. CW1 also indicated that GMCR had earlier changed the wording of its revenue recognition policy because the auditors had found discrepancies and senior management was thus aware that GMCR was accounting for revenue incorrectly.

75. In addition, a former regional sales director for Keurig between 2004 and the fall of 2010 ("CW 5"), indicated that distributors were unhappy with certain sales made to them by MBlock and that during a March 2010 sales conference call with regional directors, Keurig Vice Presidents Chris Stevens, Dan Cignarella and Dave Manly denied sales to distributors had been made by MBlock.

76. A former Vice President of Operations for GMCR during 2010 ("CW6"), stated that while the accounting department in Vermont told CW6 to book shipments to MBlock as a sale, the SEC [Securities and Exchange Commission] questioned the existence of an arms-length relationship between GMCR and MBlock. In fact, CW6 did not know if MBlock ever owned the products shipped to it. [Emphasis added.]

When did the Securities and Exchange Commission start investigating Green Mountain Coffee?

The amended complaint alleges that the company knew it was being investigated by the SEC months before it was disclosed to investors. On September 28, 2010, Green Mountain Coffee issued an 8-K report claiming that:

On September 20, 2010, the staff of the SEC’s Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information. Based on the request, the Company believes the focus of the inquiry concerns certain revenue recognition practices and the Company’s relationship with one of its fulfillment vendors. The Company, at the direction of the audit committee of the Company’s board of directors, is cooperating fully with the SEC staff’s inquiry. [Emphasis added.]

However, the amended complaint takes issue with Green Mountain Coffee's disclosure:

68. Moreover, although the September 28, 2010 Form 8-K indicates that, "[o]n September 20, 2010, the staff of the SEC's Division of Enforcement informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information," the above-noted former employee has stated that by no later than the first week of May 2010, he/she was contacted by Company employees who asked if he/she had been had been the whistleblower in an SEC investigation of GMCR.

69. Accordingly, Company employees contacted the confidential witness concerning an SEC investigation five months prior to the issuance of the September 28, 2010 Form 8-K, which disclosed that the SEC informed the Company that it was conducting an inquiry and made a request for a voluntary production of documents and information on September 20, 2010. [Emphasis added.]

From my experience at Crazy Eddie and later consulting work, I learned that the SEC usually communicates its concerns to targeted companies before sending an official notification of inquiry or investigation to them.

Alleged Illegal Insider Trading

Further, the amended complaint alleges that Michelle Stacy (President of Keurig operating segment) and Scott McCreary, (President Specialty Coffee Business Unit) engaged in illegal insider trading stemming from recent stock sales starting in August 2010:

7. Approximately one month earlier, both Stacy and Scott McCreary ("McCreary"), the President of GMCR's other business division, the Specialty Coffee Business Unit ("SCBU"), unloaded a total of 230,000 Company shares for proceeds of more than $7.5 million. These sales, which also occurred shortly before the Company's official announcement of an SEC inquiry, were made after the SEC's initial contact with GMCR. Prior to these sales, there had not been significant insider trading activity since June 2009.

In the weeks before Green Mountain Coffee claims it was notified about the SEC inquiry, Michelle Stacy and Scott McCreary simultaneously exercised options and sold large amounts of shares. On August 13, 2010, Michelle Stacy exercised 30,000 options at $6.20 per share and simultaneously sold those shares at $30.95 per share for gross proceeds of $928,500. On August 18, 2010, Scott McCreary exercised 200,000 options and $1.47 per share and simultaneously sold his shares at $33.08 per share for gross proceeds of $6.616 million. On September 13, 2010 Michelle Stacy exercised another 5,000 options at $6.20 per share and sold those shares at $35.40 for gross proceeds of $177,000.

On September 20, 2010, Green Mountain Coffee claimed that it was notified by the SEC of an informal inquiry concerning its “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.” On September 21, 2010, Michelle Stacy exercised 5,000 options and immediately sold her shares at $37 per share.

On September 28, 2010, Green Mountain Coffee disclosed the SEC inquiry to investors. In addition, the company disclosed that it discovered an "immaterial accounting error" involving its K-Cup margin percentages which resulted in a $7.6 million cumulative overstatement of pre-tax income in financial reports issued from 2007 to June 26, 2010. The company’s disclosure was vague about when it discovered K-Cup margin error:

In connection with the preparation of its financial results for its fourth fiscal quarter, the Company’s management discovered an immaterial accounting error relating to the margin percentage it had been using to eliminate the inter-company markup in its K-Cup inventory balance residing at its Keurig business unit.

In my blog, interviews by fellow Seeking Alpha contributor Ilene (here and here), and in a televised interview on WCAX TV Vermont, I expressed my concern about the possibility of illegal insider trading by Michelle Stacy and Scott McCreary based on the timing of their stock sales.

Michelle Stacy sold her shares a day after Green Mountain Coffee claimed it was notified by the SEC of its inquiry but seven days before that inquiry was disclosed to investors. Green Mountain Coffee did not disclose exactly when it initially discovered its K-Cup margin error. Usually weaknesses in internal controls that cause accounting errors are discovered months or weeks in advance of the disclosure of such errors to investors.

On October 28, 2010, Stacy belatedly filed amended Form 4 reports and claimed that her September 13 and September 21 sales of stock were "affected pursuant to a Rule 10b5-1 trading plan" established on August 13, 2010.  A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold.

The amended complaint took issue with the timing of Michelle Stacy and Scott McCreary's stock sales:

103. Prior to these sales, there had not been significant insider trading activity since June 2009. Not only did both division presidents sell the majority of their shares, but Stacy did so the day after the SEC's information request and one week before GMCR made the SEC inquiry public.

104. Even worse, in October 2010, Stacy amended her Form 4s for the August and September sales, claiming that she forgot to include in the original Form 4s that the sales were made pursuant to a Rule 10b5-1 trading plan adopted on August 13, 2010. Not only did the Company fail to inform the SEC of the plan on the day it was adopted, but it failed to disclose the plan when Stacy's Form 4 for the $928,500 sale was filed a mere four days after its adoption.

In a follow up blog post, I noted that:

If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations.

As detailed above, the amended class-action complaint alleges that Green Mountain Coffee executives knew that it was being investigated by the SEC months as early as May 2010, which was about 90 days before Michelle Stacy and Scott McCreary sold their stock and before Stacy claims she set up a 10b5-1 trading plan.

According to the SEC:

Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security.

If the class-action lawyers or the SEC can prove that Michelle Stacy or Scott McCreary knew about any material weaknesses in internal controls involving financial reporting, any material accounting errors, or an impending or actual SEC investigation and then sold their stock before it was disclosed to investors, they could be successfully prosecuted for illegal insider trading. The class-action lawyers and the SEC do not have to prove that Michelle Stacy or Scott McCreary knew of and participated in any alleged schemes to improperly inflate revenues and income to successfully prosecute them for illegal insider trading.

Closing comments

The amended complaint cites reporting by me and fellow Seeking Alpha contributor Jason Merriam:

GMCR's accounting practices have also garnered attention from the financial press. For example, in a February 13, 2011 Seeking Alpha article entitled "Green Mountain Coffee: Only Thing Brewing Is Trouble," author Jason Merriam, noted "[t]he accounting practices at Green Mountain Coffee Roasters (GMCR) are not baffling ... they are downright ludicrous." Similarly, on February 15,2011, Sam Antar began his Seeking Alpha article, entitled "More Mucky Disclosures For Green Mountain Coffee Roasters," with the following sentence: "Just about every time I examine financial reports issued by Green Mountain Coffee Roasters (NASDAQ: GMCR), I find new troubling accounting practices and financial disclosures. [Emphasis added.]

In my Seeking Alpha article, I detailed how starting in the quarter ended December 25, 2009 Green Mountain Coffee restated its segment numbers without disclosing it to investors months before it announced the SEC inquiry and certain accounting errors. The company's restatement of segment numbers may indicate that it was aware of material weaknesses in internal controls over in its financial reporting as far back as 2009.

In another blog post, I questioned whether Green Mountain Coffee correctly determined that its K-Cup margin error was an "immaterial accounting error" when it was initially disclosed on September 28, 2010. My analysis showed that the K-Cup margin error caused Green Mountain Coffee to overstate profits and beat analysts' consensus earnings expectations in the quarter ended March 27, 2010. According the SEC Staff Accounting Bulletin No. 99, Green Mountain should have considered its K-Cup margin error as a material accounting error on September 28, 2010 and it should have immediately disclosed to investors that it was going to restate its financial reports from 2007 to 2010 to correct that error.

Instead, Green Mountain Coffee waited until November 19, 2010 to inform investors that it was going to restate its financial reports when it disclosed three new overstatements totaling $3.2 million pre-tax income and one new understatement of $0.7 million in pre-tax income. These errors plus the K-Cup margin error resulted in a total overstatement of $10.1 million in pre-tax income. This time, the company said it would restate its financial reports issued from 2007 to 2010 to correct its errors.

In addition, the company claimed that its own internal investigation cleared it of misconduct. I told Ilene, fellow Seeking Alpha contributor and editor at Phil's Stock World:

In any case, I am naturally suspicious of self-proclaimed absences of wrongdoing without thorough outside independent examination. Back in the old days at Crazy Eddie, we conducted a similar internal inquiry with help from our auditors into certain allegations of wrongdoing involving a supplier and proclaimed ourselves clean… Management and auditors have little incentive to report their own foul-ups.

To date, Green Mountain Coffee has not specifically disclosed details of who conducted the internal investigation, how it was conducted, or why the company missed certain red flags. For all we know, it could be the janitor who conducted the company's internal investigation.

In my last blog post, I wrote an open letter to Green Mountain Coffee's Chief Financial Officer Frances G. Rathke questioning unusual numbers reported for its Timothy's Coffee subsidiary. I questioned how the company missed a 75% overstatement of revenues for Timothy's Coffee in the quarter ended December 26, 2009 and how the subsidiary was able to report income before taxes in excess of revenues in the quarter ended June 26, 2010. So far, Rathke has not responded to me.

I've been able to identify financial reporting irregularities from just reading and analyzing Green Mountain Coffee's financial reports. However, the class-action lawyers and the SEC have the power to subpoena witnesses and compel the production of internal documents from Green Mountain Coffee and M. Block to get at the bottom of what happened.

Last quarter, Green Mountain Coffee disclosed that it spent about $6 million on "legal and accounting expenses related to the SEC inquiry, the Company’s internal investigation and pending litigation." I don't see any quick resolution of legal issues facing Green Mountain Coffee and the company should expect to spend significantly more money dealing with these issues in future periods. Back on October 21, 2010, I warned Green Mountain Coffee that "Your lawyers will defend you to your very last dollar."

Written by:

Sam E. Antar

Recommended reading:

February 11, 2011: Dag Blog -"Crazy Eddie" Fraudster Sam Antar To Return To Crime - Thanks to Darrell Issa & Anti-Regulation Republicans by William K. Wolfrum

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of these companies are a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.

Green Mountain Coffee Roasters, Time to Spill the Beans?

To truly exonerate itself after the discovery of certain material violations of Generally Accepted Accounting Principles (GAAP), Green Mountain Coffee Roasters (NASDAQ: GMCR) needs to come clean with investors and disclose exactly when it found certain accounting errors. In addition, Green Mountain needs to provide clearer and more transparent disclosures to investors about the Securities and Exchange Commission (SEC) inquiry and the discovery of those errors.

Timing of certain disclosures

On Monday, September 20, 2010, the SEC notified Green Mountain Coffee Roasters that it was conducting an informal inquiry and requested it voluntarily submit information concerning “revenue recognition practices and the Company’s relationship with one of its fulfillment vendors.”

Eight days later, on September 28, 2010, Green Mountain surprised investors by disclosing news of the SEC inquiry in an 8-K filing with the SEC. In that same 8-K report, Green Mountain disclosed that it discovered an "immaterial accounting error" affecting financial reports issued from 2007 to 2010:

In connection with the preparation of its financial results for its fourth fiscal quarter, the Company’s management discovered an immaterial accounting error relating to the margin percentage it had been using to eliminate the inter-company markup in its K-Cup inventory balance residing at its Keurig business unit. Management discovered that the gross margin percentage used to eliminate the inter-company markup resulted in a lower margin applied to the Keurig ending inventory balance effectively overstating consolidated inventory and understating cost of sales. Management determined that the accounting error arose during fiscal 2007 and analyzed the quantitative impact from that point forward to June 26, 2010.

As of June 26, 2010, there is a cumulative $7.6 million overstatement of pre-tax income. Net of tax, the cumulative error resulted in a $4.4 million overstatement of net income or a $0.03 cumulative impact on earnings per share.

After evaluating the quantitative and qualitative aspects of the error in accordance with applicable accounting literature, including Staff Accounting Bulletins published by the SEC, the Company, with the participation of the audit committee of the Board of Directors, has determined that the correction in the margin calculation represents a correction of an error in accordance with Accounting Standards Codification 250 Accounting Changes and Error Corrections, that the correction was not material to the fiscal years and the respective quarters ended 2007, 2008 and 2009 and that the Company anticipates that the correction will not be material to fiscal year 2010 and the respective quarters of fiscal 2010. As a result, the Company anticipates the cumulative amount of the accounting correction will be made in the quarter ended September 25, 2010. [Bold and italicized emphasis added.]

Green Mountain did not disclose exactly when it discovered the margin error but only that the margin error was discovered “In connection with the preparation of its financial results for its fourth fiscal quarter…..” Green Mountain’s fiscal year ended on September 25, 2010. Usually companies prepare for their year-end audits up to two months in advance.

Two scenarios

If Green Mountain had discovered the margin error before it was notified about the SEC inquiry, on September 20, 2010, why didn’t the company disclose the margin error to investors earlier, instead of waiting until it filed its 8-K report September 28, 2010?

If Green Mountain discovered the margin error after it was notified about the SEC inquiry, on September 20, 2010, why was the company able to find an accounting error within eight days or by September 28, 2010, when it didn't find the error during the previous fiscal years (2007 to 2010)? This scenario is possible, but it would be very coincidental.

The unknown timing of Green Mountain’s discovery of its margin error raises the question: did the company disclose the error to investors when it was discovered or did the company wait?

Green Mountain’s Common Stock Purchase Agreement with Luigi Lavazza S.p.A.

In that same September 28, 2010 8-K report, Green Mountain disclosed that it closed its Common Stock Purchase Agreement with Luigi Lavazza S.p.A. See below:

On September 28, 2010, Green Mountain Coffee Roasters, Inc., a Delaware corporation (the “Company”), completed a sale of 8,566,649 shares (the “Shares”) of its common stock, par value $0.10 per share (“Common Stock”), to Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), for an aggregate purchase price of $250,000,000. The sale of the Shares was effected pursuant to the Common Stock Purchase Agreement, dated as of August 10, 2010 (the “SPA”), by and between the Company and Lavazza. The execution of the SPA was previously reported by the Company in its Current Report on Form 8-K filed by the Company with the Securities and Exchange Commission (the “SEC”) on August 11, 2010, and the full text of the SPA was filed as Exhibit 10.1 thereto. 

In connection with the stock purchase agreement, Green Mountain provided certain warranties that the Company and its auditors have not identified and are not aware of:

(A) any significant deficiency or material weakness in the design or operation of internal control over financial reporting utilized by the Company; (B) any illegal act or fraud, that involves the Company’s management or other employees; or (C) any claim or allegation regarding any of the foregoing that would have a Material Adverse Effect. [Bold and italicized emphasis added.]

According to Statement of Auditing Standards No. 115:

.07 A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance.

A material weakness in internal controls generally arises when accounting errors have a “reasonable possibility” of causing a company to restate its financial reports to correct those errors. A "significant deficiency" in internal controls arises when accounting errors are not material enough to cause a restatement of financial reports, but are instead corrected by making a cumulative adjustment to the latest period’s financial reports.

Initially, Green Mountain claimed that its margin error was “immaterial” and disclosed that it would correct that error by making a cumulative adjustment to its Q4 2010 financial reports, rather than restate its financial reports issued from 2007 to 2010. At the very least, that margin error appeared to result from a “significant deficiency” under auditing rules. It could be a breach of warranty under Green Mountain’s Common Stock Purchase Agreement with Luigi Lavazza, though Green Mountain never told investors that may have breached a key warranty under its agreement with Luigi Lavazza.

Green Mountain initially entered into its agreement to sell shares to Luigi Lavazza on August 10, 2010. On the following day, Green Mountain disclosed to investors that:

On August 10, 2010, Green Mountain Coffee Roasters, Inc., a Delaware corporation (“Green Mountain” or the “Company”), and Luigi Lavazza S.p.A., an Italian corporation (“Lavazza”), entered into a Common Stock Purchase Agreement (the “SPA”). Pursuant to the terms of the SPA, Lavazza has agreed to make a $250,000,000 investment (the “Investment”) in Green Mountain’s common stock, par value $0.10 per share (“Common Stock”), at a purchase price per share equal to the volume-weighted average price of the Common Stock for the 60 trading days before the closing of the Investment, less 7.5% (the “Shares”). [Bold and italicized emphasis added.]

Thus, Lavazza's "purchase price per share would be equal to the volume-weighted average price of the Common Stock for the 60 trading days before September 28, 2010, less 7.5% (the “Shares”).” If the share price were to have dropped prior to Sept. 28, it would be reflected in Lavazza's final purchase price.

Based on the agreed upon terms, Luigi Lavazza paid $250 million to purchase 8,566,649 shares, or an average price per share of $29.18 which was computed as follows:

$31.55 gross volume-weighted average price of the Common Stock less 7.5% discount or $2.37 equals $29.18.

On September 28, 2010, Green Mountain closed its Common Stock Purchase Agreement with Luigi Lavazza. Later that same day, after the stock market closed, the company finally disclosed the SEC inquiry and the discovery of the margin error to investors.

On September 29, 2010, Green Mountain stock dropped $5.95 per share to close at $31.06 per share, a 16.1% drop in market value that day in reaction to news of the SEC inquiry and accounting error. The stock continued to drop to $26.87 per share on October 11, 2010.

Green Mountain’s gross "volume-weighted average price" per share of stock in the sixty trading days prior to closing its Common Stock Purchase Agreement with Luigi Lavazza was about $31.55 per share. Apparently, if Green Mountain had waited to close the deal until after it disclosed news of the SEC inquiry and margin error, Luigi Lavazza would have paid less money per share to the company. This leads to the question: did Green Mountain purposely delay disclosure to investors of the SEC inquiry, the margin error, significant weaknesses in internal controls, and possible breaches of representations and warranties under its agreement with Luigi Lavazza?

Or did Green Mountain give early warning to Luigi Lavazza under the terms of their confidential agreement? (See Common Stock Purchase Agreement Section 7). In such case, did Luigi Lavazza not care about the probable negative impact on the stock price after the SEC inquiry and margin errors were disclosed to investors? And if so, why not?

More accounting errors discovered

On November 19, 2010, Green Mountain filed an 8-K report updating investors about the margin error it disclosed on September 28, 2010 and also disclosed additional accounting errors:

["Margin error"] A $7.6 million overstatement of pre-tax income, cumulative over the restated periods, due to the K-Cup inventory adjustment error previously reported in the Company’s Form 8-K filed on September 28, 2010. This error is the result of applying an incorrect standard cost to intercompany K-Cup inventory balances in consolidation. This error resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales. Rather than correcting the cumulative amount of the error in the quarter ended September 25, 2010, as disclosed in the September 28, 2010 Form 8-K, the effect of this error will be recorded in the applicable restated periods.

A $1.4 million overstatement of pre-tax income, cumulative over the restated periods, due to the under-accrual of certain marketing and customer incentive program expenses. The Company also has corrected the classification of certain of these amounts as reductions to net sales instead of selling and operating expenses. These programs include, but are not limited to, brewer mark-down support and funds for promotional and marketing activities. Management has determined that miscommunication between the sales and accounting departments resulted in expenses for certain of these programs being recorded in the wrong fiscal periods.

A $1.0 million overstatement of pre-tax income, cumulative over the restated periods, due to changes in the timing and classification of the Company’s historical revenue recognition of royalties from third party licensed roasters. Because royalties were recognized upon shipment of K-Cups by roasters pursuant to the terms and conditions of the licensing agreements with these roasters, Keurig historically recognized these royalties at the time Keurig purchased the K-Cups from the licensed roasters and classified this royalty in net sales. Management has determined to recognize this royalty as a reduction to the carrying cost of the related inventory. The gross margin benefit of the royalty will then be realized upon the ultimate sale of the product to a third party customer. Due to the Company’s completed and, when consummated, pending acquisitions of third party licensed roasters, these purchases and the associated royalties have become less of a factor, since the post-acquisition royalties from these wholly-owned roasters are not included in the Company’s consolidated financial statements.

An $800,000 overstatement of pre-tax income, cumulative over the restated periods, due to applying an incorrect standard cost to intercompany brewer inventory balances in consolidation. This error was identified during the preparation of the fiscal year 2010 financial statements and resulted in an overstatement of the consolidated inventory and an understatement of the cost of sales.

A $700,000 understatement of pre-tax income for the Specialty Coffee business unit, due primarily to a failure to reverse an accrual related to certain customer incentive programs in the second fiscal quarter of 2010. The over-accrual was not identified and corrected until the fourth fiscal quarter of 2010.

In addition to the errors described above, the Company also will include in the restated financial statements certain other immaterial errors, including previously unrecorded immaterial adjustments identified in audits of prior years’ financial statements. [Bold and italicized emphasis added.]

Green Mountain also claimed that:

… these errors were discovered by management during the course of its preparation of the year-end financial statements and audit, as well as during the course of an internal investigation initiated by the audit committee of the Company’s board of directors in light of the previously disclosed inquiry by the staff of the Securities and Exchange Commission’s (“SEC”) Division of Enforcement. [Bold and italicized emphasis added.]

In its September 28, 2010 8-K report, Green Mountain claimed that the margin error was discovered “In connection with the preparation of its financial results for its fourth fiscal quarter.” Presumably, the additional errors listed in the November 19, 2010 8-K report were discovered during the internal investigation after the SEC notified the company of it informal inquiry.

We still don’t know exactly when Green Mountain discovered the margin error, whether it was before or after the company learned about the SEC inquiry on September 20, 2010. However, we now know that Green Mountain found several new accounting errors about sixty days after it was notified of the SEC inquiry. It also appears that Green Mountain is taking the position that its errors were "immaterial."

Materiality of accounting errors

Originally on September 28, 2010, Green Mountain disclosed that it overstated pre-tax income from 2007 to 2010 because of the margin error. The company claimed that the margin error was “immaterial” and said it would correct that error by making a cumulative adjustment to earnings “in the quarter ended September 25, 2010.”

On November 19, 2010, Green Mountain disclosed three new overstatements totaling $3.2 million pre-tax income and one new understatement of $0.7 million in pre-tax income, making a total overstatement of $10.1 million in pre-tax income. This time, the company announced that it would restate its financial reports issued from 2007 to 2010 to correct all of its errors:

On November 15, 2010, the board of directors of Green Mountain Coffee Roasters, Inc. (the “Company”), based on the recommendation of the audit committee and in consultation with management, concluded that, because of errors identified in the Company’s previously issued financial statements for the fiscal years ended September 29, 2007, September 27, 2008 and September 26, 2009 and the first three fiscal quarters of 2010, the Company will restate its previously issued financial statements, including the quarterly data for fiscal years 2009 and 2010 and its selected financial data for the relevant periods. Accordingly, investors should no longer rely upon the Company’s previously released financial statements for these periods and any earnings releases or other communications relating to these periods. [Bold and italicized emphasis added.]

Green Mountain did not identify any specific accounting error as "material." However, under SEC Staff Accounting Bulletin No. 99, accounting errors are material when they cause the "financial statements taken as a whole" to be "materially misstated" or "materially misleading." Such errors must be corrected by restating financial reports, instead of using a cumulative adjustment to the latest quarter's report to correct those errors.

How Green Mountain tried to spin the materiality issue

In its November 19, 2010 8-K report, Green Mountain tried to minimize to seriousness of its accounting errors by using carefully crafted language claiming that:

The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements.

The adjustments necessary to correct the errors will have no effect on reported cash flow from operations, and are not expected to have a material impact on the balance sheet.

Such errors can still be cause "financial statements taken as a whole" to be "materially misstated" or "materially misleading." SAB No. 99 directly addresses that issue:

If the misstatement of an individual amount causes the financial statements as a whole to be materially misstated, that effect cannot be eliminated by other misstatements whose effect may be to diminish the impact of the misstatement on other financial statement items. To take an obvious example, if a registrant's revenues are a material financial statement item and if they are materially overstated, the financial statements taken as a whole will be materially misleading even if the effect on earnings is completely offset by an equivalent overstatement of expenses.

Even though a misstatement of an individual amount may not cause the financial statements taken as a whole to be materially misstated, it may nonetheless, when aggregated with other misstatements, render the financial statements taken as a whole to be materially misleading. [Bold and italicized emphasis added.] 

For example, Company A and Company B are both competitors and each company has $100 of revenue, $100 of expenses, and zero profits. Both companies make only cash sales to customers and pay all of their expenses in cash. Each company started and ended the year with $100 in cash because they had zero profits.

Company A wants to make it appear that it has more market share (revenues) than company B and it inflates revenues and expenses by $100 each to report $200 of revenues, $200 of expenses, and but still zero profits. At the end of the year both companies report zero profits, zero cash flows from operations, and $100 cash on their balance sheets.

Company A's inflation of revenues and expenses did not change its reported profits, cash flow from operations, or balance sheet. However, Company A materially overstated both its revenues and expenses. Therefore, Company A's financial statements "taken as a whole" were "materially misleading."

Green Mountain said that "The effects on certain reported periods are quantitatively significant, and the impact of the individual errors will be disclosed in more detail in the Company’s restated financial statements." However, Green Mountain made no specific mention that its "financial statements taken as a whole" were "materially misstated" or "materially misleading."

Green Mountain should explain its decision to consider the margin error as an "immaterial accounting error"

When Green Mountain issues its restated financial reports, it should provide a thorough analysis and explain to investors why, originally on September 28, 2010, it considered the margin error “immaterial” and initially decided to use a cumulative adjustment to Q4 2010’s financial report to correct that error instead of restating its financial reports.

When the SEC Division of Corporation Finance conducts periodic reviews of public company financial reports and finds accounting errors, it requires the companies to provide a detailed materiality analysis using criteria under SAB No. 99. The analysis is later made publicly available in company filings after the review is completed. At the very least, Green Mountain should provide this analysis to investors when it files its 2010 annual 10-K report.

According to SAB No. 99:

Among the considerations that may well render material a quantitatively small misstatement of a financial statement item are –  

• whether the misstatement arises from an item capable of precise measurement or whether it arises from an estimate and, if so, the degree of imprecision inherent in the estimate 
• whether the misstatement masks a change in earnings or other trends   
• whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise   
• whether the misstatement changes a loss into income or vice versa  
• whether the misstatement concerns a segment or other portion of the registrant's business that has been identified as playing a significant role in the registrant's operations or profitability  
• whether the misstatement affects the registrant's compliance with regulatory requirements
• whether the misstatement affects the registrant's compliance with loan covenants or other contractual requirements   
• whether the misstatement has the effect of increasing management's compensation – for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation 
• whether the misstatement involves concealment of an unlawful transaction. 

This is not an exhaustive list of the circumstances that may affect the materiality of a quantitatively small misstatement. Among other factors, the demonstrated volatility of the price of a registrant's securities in response to certain types of disclosures may provide guidance as to whether investors regard quantitatively small misstatements as material. Consideration of potential market reaction to disclosure of a misstatement is by itself "too blunt an instrument to be depended on" in considering whether a fact is material. When, however, management or the independent auditor expects (based, for example, on a pattern of market performance) that a known misstatement may result in a significant positive or negative market reaction, that expected reaction should be taken into account when considering whether a misstatement is material.

If Green Mountain's margin error fell under any of the criteria listed above, it should have been considered a material accounting error under SAB No. 99, rather than an "immaterial accounting error" as originally claimed by the company.

Insider sales of stock

In a previous blog post, I detailed how on September 21, 2010, a day after Green Mountain was notified of the SEC inquiry, but seven days before the SEC inquiry was disclosed to investors, executive officer Michelle Stacy exercised 5,000 options and immediately sold her shares at $37 per share. At that time, Michelle Stacy's Form 4 disclosure did not reflect that she sold her shares pursuant to a Rule 10b5-1 trading plan. A Rule 10b5-1 trading plan provides certain safe harbors which help executives defend against potential allegations of illegal insider-trading by removing their discretion to decide when their stock is bought or sold.

About five weeks after that blog post, on October 28, 2010, Stacy belatedly filed an amended Form 4 report and disclosed that:

This Form 4 has been amended to note that these sales were affected pursuant to a Rule 10b5-1 trading plan adopted by Ms. Stacy on 08/13/2010. 

In addition, Michelle Stacy filed another amended Form 4 report to reflect that her September 13, 2010 option exercise and sale of stock was also "affected pursuant to a Rule 10b5-1 trading plan." That option exercise and sale took place just seven days before Green Mountain was notified by the SEC on an inquiry.

At the very least, Michelle Stacy’s filing of amended Form 4 reports displays a continuous pattern of problematic financial reporting by Green Mountain and its officers and which increases investor uncertainty about the integrity of the company’s SEC filings.

Many responsible companies voluntarily disclose their insider's 10b5-1 trading plans as they are adopted, even though such disclosure is not required under existing SEC rules. The existence of 10b5-1 trading plans are only required to be disclosed on Form 4 as insiders purchase or sell their stock pursuant to such plans. However, voluntary disclosure at the inception of a 10b5-1 trading plan by insiders increases corporate transparency.

On August 13, 2010, Michelle Stacy exercised 30,000 options and immediately sold her shares at $30.95 per share. Not till October 28 did Stacy file amended Form 4 reports to reflect that her September 13th and 21st option exercises and sales of stock were carried out pursuant to a Rule 10b5-1 trading plan. Stacy claimed that she adopted a 10b5-1 trading plan on August 13. On August 13th, Stacy exercised options and sold stock, but she still does not claim that those transactions were made pursuant to a 10b5-1 trading plan.

If a corporate executive already has nonpublic knowledge of certain adverse events such as undisclosed weaknesses in internal controls, accounting errors, or an SEC inquiry, a 10b5-1 plan cannot provide a safe harbor against illegal insider trading allegations. If it turns out that Michelle Stacy had non-public knowledge of any of those issues affecting Green Mountain before adopting her 10b5-1 trading plan, she could be charged by the SEC with alleged insider trading violations. Several lawsuits seeking class action status have already alleged securities law violations by Green Mountain and its officers.

Usually 10b5-1 trading plans call for the purchase or sale of stock by insiders at regular intervals.  Michelle Stacy’s plan doesn't appear particularly regular. On Monday, September 13, 2010, she exercised options and sold 5,000 shares of Green Mountain stock. Eight days later on Tuesday, September 21, 2010 (and a day after Green Mountain received notification of the SEC inquiry) she exercised options and sold another 5,000 shares of Green Mountain stock. Forty-five days later, on November 5, 2010, Michelle Stacy exercised options and sold 10,000 shares of Green Mountain stock. In the interest of transparency, Michelle Stacy should explain how the timing of option exercises and sales were determined under her 10b5-1 plan.

PricewaterhouseCoopers

PricewaterhouseCoopers is Green Mountain’s current auditor and it is now evident that it missed a growing list of accounting errors covering fiscal years 2007 to 2010. Likewise, until 2009 PricewaterhouseCoopers was Overstock.com’s (NASDAQ: OSTK) auditors, too. Every single initial financial report issued by Overstock.com from 1999 to 2009 had to be restated at least once and as many as three times due to accounting errors. Therefore, PricewaterhouseCoopers missed accounting errors by Overstock.com in each and every audit it performed of the company.

In 2009, I identified certain violations of Generally Accepted Accounting Principles (GAAP) which ultimately caused Overstock.com to restate its financial reports for the third time in three years, after the SEC intervened and forced to company to correct its accounting errors. During the ongoing SEC investigation, PricewaterhouseCoopers defended Overstock.com’s improper accounting treatment of cost recoveries from vendors and as it turns out, they were wrong.

Prematurely proclaiming the absence of wrongdoing 

In its November 19, 2010 8-K report, Green Mountain claimed that none of the financial statement errors implicate misconduct with respect to the Company or its management or employees:

The internal investigation is nearly complete, and the Company continues to cooperate fully with the SEC. None of the financial statement errors implicate misconduct with respect to the Company or its management or employees. In addition, none of the financial statement errors are related to the Company’s relationship with M.Block & Sons, the fulfillment vendor through which the Company makes a majority of the at-home orders for the Keurig business unit’s single-cup business sold to retailers. [Bold and italicized emphasis added.]

It is premature for Green Mountain to proclaim the absence of any wrongdoing while the SEC inquiry is still ongoing and it admits that its own internal investigation is not fully completed. The SEC inquiry began on September 20 and has not been concluded. That statement will come back to haunt Green Mountain if the SEC decides to conduct a formal investigation.

In any case, I am naturally suspicious of self-proclaimed absences of wrongdoing without thorough outside independent examination. Back in the old days at Crazy Eddie, we conducted a similar internal inquiry with help from our auditors into certain allegations of wrongdoing involving a supplier and proclaimed ourselves clean. The auditors falsely claimed to both our audit committee and the SEC that they thoroughly checked out those allegations and found no wrongdoing. Management and auditors have little incentive to report their own foul-ups.

Final comment

Every financial report issued by Green Mountain and certified by PricewaterhouseCoopers from 2007 to 2010 had to be restated because of accounting errors. In addition, Green Mountain CEO Lawrence J. Blanford and CFO Frances G. Rathke signed Sarbanes-Oxley certifications covering those reports. So far no one has been held accountable by Green Mountain for its financial misstatements – not its auditors, CFO, or CEO.

While I personally like the smell of Green Mountain's coffee, I don't like the smell of its financial disclosures. A little more enthusiasm in cleaning up its financial reporting (like it devotes to cleaning up the environment) and a little more transparency would go a long way.

Written by,

Sam E. Antar (with research assistance from Ilene)

Recommended reading about issues with 10b5-1 trading plans

February 1, 2009: Stanford University Graduate School of Business - Sec Rule 10b5-1 and Insiders' Strategic Trade by Alan D. Jagolinzer

July 2009: Stanford University Graduate School of Business - Research Underpins SEC Scrutiny of Scheduled Insider Trades by Bill Snyder

Disclosure

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped my cousin Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes in cold-blood for fun and profit, and simply because I could.

If it weren't for the heroic efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

There is a saying, "It takes one to know one." Today, I work very closely with the FBI, IRS, SEC, Justice Department, and other federal and state law enforcement agencies in training them to identify and catch white-collar criminals. Often, I refer cases to them. I teach about white-collar crime for professional organizations, businesses, and colleges and universities.

Recently, I exposed GAAP violations by Overstock.com which caused the company to restate its financial reports for the third time in three years. The SEC is now investigating Overstock.com and its CEO Patrick Byrne for securities law violations (Details here, here, and here).

I do not seek or want forgiveness for my vicious crimes from my victims. I plan on frying in hell with other white-collar criminals for a very long time.

I do not own any Green Mountain Coffee Roasters or Overstock.com securities long or short. My investigations of those companies is a freebie for securities regulators to get me into heaven, though I doubt I will ever get there. My past sins are unforgivable.