Case 3-9 Loyalty to the Boss, Company, and/or the Profession: Whistleblowing as a Lever (a GVV Case)

Jerry Maloney, CPA has been working at Mason Pharmaceuticals for fifteen years. Mason is a Fortune 1000 company whose stock trades on the New York Stock Exchange. He came to Mason after starting his career in the Audit practice of PwC working on clients in the Pharmaceuticals and Medical Device manufacturing industries. Jerry loves and is very loyal to both the industry he works in and the company he works for. He believes that the drugs they manufacture save lives and he is committed to the continued success of the company. He started out as an Assistant Manager of Internal Audit at Mason, later led the internal audit division, and then moved into the Financial Reporting Department. His hard work has paid off and he was recently promoted to Senior Manager of Financial Reporting, reporting directly to the CFO. His department is responsible for preparing and ensuring the accuracy of all the required filings to the SEC and the NYSE. While his boss must certify the accuracy of the financials, the CFO relies on Jerry to ensure compliance with GAAP and that all the reporting requirements of the SEC and the NYSE are followed. Jerry is sitting in his office reviewing a preliminary draft of the 10Q for the third quarter ended September 30, 2018. He is smiling as he reads the report as their Earnings Per Share (EPS) figures have exceeded their projected numbers for the third quarter in a row and he knows upper management will be thrilled. As he sits and contemplates what this might mean in terms of bonuses, raises, and stock valuation, Sharon Diggins, the Manager of Financial Reporting, knocks on his door. He invites her in and she explains that their staff have just found a material understatement of expenses in the draft 10Q. She explains that Research and Development Costs had been inadvertently capitalized as direct materials inventory and they needed to reverse that entry before issuing a final 10Q with the SEC. The reversal will cause them to fall just short of their expected EPS figures. Mason had a big win in gaining regulatory approval for an impressive new treatment for Colorectal Cancer. The company expects this new drug to produce more revenue than any drug they have manufactured to date. Sharon explains that some manager in purchasing had inadvertently purchased a six months supply of the primary compound needed to produce the drug a month before regulatory approval was received. Unfortunately, the compound was received just a week before regulatory approval was granted. The accounts payable clerk recorded the invoice for the compound as Direct Materials Inventory as the intent was to use the materials for the manufacture of the new drug. Under GAAP all such costs need to be expensed as Research and Development Costs up until regulatory approval is received. Jerry is distraught over the fact that the internal audit department did not catch this error sooner. He discusses with Sharon that they will need to investigate the oversight later but right now their larger issue is getting the reports revised. He explains that convincing John Bender, the CFO, that they need to correct this error now will be difficult. Bender is also reviewing the same draft of the 10Q that Jerry has and must be delighted by the apparent results. Jerry is sure he will argue against expensing the cost of the compound. He can just imagine that at a minimum Bender will argue that following GAAP to the letter does not make sense. The intent of the purchase was to produce the drug, which they will do starting in the current quarter. He is sure Bender will state following GAAP will actually reduce the true cost of goods sold next quarter and, therefore, they should leave the cost in inventory. Sharon reminds Jerry that a violation of GAAP of this magnitude would be considered fraudulent financial reporting by the SEC and cannot be allowed to happen. She suggests that they put their GVV training to work and try to identify all the arguments that Bender will use to try and convince them to ignore this error and then prepare counter arguments. Jerry agrees and they get to work formulating their plan for discussing this matter with Bender.

1- What are the main arguments that Jerry and Sharon will need to counter? That is, what are the reasons and rationalizations they will need to address? 2-What is at stake should they not convince Bender to issue a revised 10Q? 3-What levers do Jerry and Sharon have available to them? Include in your answer a discussion of the provisions under SOX and how they might be used as a lever. 4-If they cannot convince Bender to issue the revised report, what is their next step? To whom should they report this matter to? Include other parties they might be able to involve who will support their position. 5-If they are unable to stop the draft report from being issued, what are their options?"