[SOLVED] The SEC bought an action against BMW

The SEC bought an action against BMW NA for inaccurate disclosures of its retail vehicle sales volume in the United States. In order to close the gap between actual retail sales volume and internal retail sales targets, and in an effort to publicly maintain a leading position relative to other premium automotive companies, BMW’s domestic subsidiary, BMW NA, engaged in an effort to increase the number of publicly-reported retail vehicle sales in the U.S. BMW NA used practices that had the effect of inaccurately reporting its U.S. retail vehicle sales volume (a non-financial metric). The company also used reserves to adjust period sales revenue to smooth earnings between periods.
The SEC’s order found that BMW AG, BMW NA, and BMW US Capital (hereinafter referred to as BMW) violated antifraud provisions of Sections 17(a)(2) and (3) of the Securities Act of 1933. Although BMW didn’t admit nor deny anything, it agreed to pay the $18 million fine and completely stop violating the provisions.
Sales Volume
From January 2015 through March 2017, BMW used its demonstrator and service loaner programs to boost reported retail sales volume and meet internal targets, resulting in demonstrator and loaner vehicles accounting for over one quarter of BMW NA’s reported retail sales in this period. BMW offered independently-owned BMW auto dealers’ financial incentives to designate (or “punch”) vehicles as demonstrators (i.e., vehicles used for test drives, showroom displays, or other marketing purposes) or service loaners, so that those vehicles would be counted by BMW as retail sales, even though the dealers had not sold the vehicles to customers.
This was done without regard to whether dealers had a legitimate business need for additional demonstrators and service loaners, or whether the dealers put those vehicles to use as demonstrators or service loaners. BMW engaged in this conduct toward the end of a given month, often on the last day, when it became apparent that BMW would be unable to meet its internal retail sales volume target through additional sales to dealerships’ customers. Faced with these shortfalls, BMW used end-of-month practices that improperly increased reported retail sales and created a misleading impression of their sales performance in the U.S. market, despite internal concerns about these practices.
Excess Reserves
From 2015 through 2019, BMW maintained an excess reserve of unreported retail vehicle sales that it used when necessary to meet internal targets in a given month, without proper regard to when the underlying retail sales actually occurred. BMW referred to these unreported retail sales as the “bank,” and managed the bank to keep a supply of unreported retail sales available when needed to meet internal retail sales targets. It also falsely designated some of its vehicles as sold when they had not yet been sold. The company even adjusted its sales reporting calendar in 2015 and 2017 to meet targets and/or bank excess sales for future use.
The use of the bank was part of BMW’s ongoing planning. In months when
BMW expected retail sales to be slow because of seasonal variation, such as January and February, BMW built into its planning assumptions the use of banked retail sales. In addition, when BMW anticipated difficulty achieving its internal retail sales targets for a month, it used banked retail sales as a cushion to effectively reduce the targets for that month. For instance, in January 2015, BMW management explained that they were following “the original plan . . . to use 1,200 units from the bank” to help achieve the target, and that “[a]ny shortfall to the January target will be taken from the planned March Bank.”
The use of the bank was planned and approved by BMW management. For instance, in September 2016, BMW management discussed that the forecasted number of retail sales for that month “includes bank withdrawal of 2,325.” BMW publicly reported 25,389 retail sales for September 2016, which included these 2,325 banked retail sales. For October 2016, BMW reported retail sales of 24,017 BMW brand vehicles, after a BMW executive decided to “[p]ick a number slightly above 24k and bank the rest.”
Internal Audit
BMW’s Internal Audit group detected two of the retail sales reporting practices being used by the company and recommended that the practices be discontinued, but BMW failed to implement these recommendations in a timely manner.
In May 2015, Internal Audit determined that BMW was using demonstrators and loaners to accelerate reporting of retail vehicle sales. Internal Audit further determined that the Specialty 8 demonstrator program was used to “fine tune monthly retail figures” and that demonstrators typically remained with dealers at the time they were reported as retail sales.
In response to Internal Audit’s findings, BMW management responded that the use of Specialty 8 demonstrators was “the most efficient instrument to meet sales targets.” Internal Audit recommended limiting what percentage of overall retail sales could consist of demonstrators and service loaners, and carefully monitoring the use of these categories. However, BMW failed to promptly implement changes to address Internal Audit’s concerns. Six months later, in November 2015, Internal Audit determined that the company had failed to take sufficient measures to avoid “unjustified retail reporting” and that dealer inventory of Specialty 8 demonstrators had actually increased.
Starting in March 2015, Internal Audit also repeatedly identified and objected to
BMW’s use of the “bank.” Internal Audit noted that the company’s use of the bank was tied to “meeting requested monthly or quarterly targets.” Internal Audit cautioned that these “[r]etail sales reporting inaccuracies lead to an inappropriate assessment of sales performance and may result in unsustainable marketing and sales business practices,” and recommended that BMW cease using the bank. Over the next few years, Internal Audit repeatedly warned about the use of the bank, but BMW did not discontinue the practice until 2020.
BMW management also discussed the use of the bank with BMW AG personnel. In at least one instance, BMW AG told BMW NA that it could bank retail sales from the prior year because BMW AG had already achieved its internal targets without those additional retail sales.
Bond Offerings
BMW raised approximately $18 billion through seven bond offerings on the U.S. capital markets from 2016 through 2019, which were offered and sold to investors pursuant to Rule 144A promulgated under the Securities Act. In connection with these bond offerings, BMW provided information about BMW’s U.S. retail vehicle sales volume and dollars to bond investors, initial purchasers, and credit rating agencies in offering memoranda and investor presentations. BMW also issued monthly press releases during this period regarding BMW’s U.S. retail sales.
These disclosures of retail sales were inaccurate and misleading because they improperly included vehicles that had been designated at month-end as demonstrators and loaners solely for purposes of artificially increasing reported sales, regardless of whether additional demonstrators and loaners were needed by dealers or were used as such, and failed to disclose the magnitude of BMW’s improper use of demonstrators and loaners, the extent to which these practices contributed to reported U.S. retail sales, and the use of the bank and retail sales reporting calendar modifications. BMW, therefore, provided materially incomplete and inaccurate information regarding its U.S. retail sales performance and customer demand for BMW vehicles in the U.S. market.
Questions:
1. What was the motivation of BMW in developing the two practices discussed in the case? Did its practices adhere to the concept of representational faithfulness? Explain.
2. Would you consider the practice of falsifying unit sales volume a financial shenanigan? How about the use of excessive reserves to affect reported numbers for sales revenue? Explain.
3. Consider the role of the internal auditors in identifying the improper financial reporting practices. Did they meet their ethical obligations in dealing with those matters? What else could they have done?

Question: The SEC bought an action against BMW