California-based Mattel Inc. has agreed to pay $3.5m in order to settle charges laid by the Securities and Exchange Commission (SEC) after findings of tax misstatements in the company’s third and fourth quarter 2017 financial statements.

According to SEC’s order, the company’s tax-related valuation allowance for Q3 of 2017 was understated by $109m and the tax expense for Q4 of 2017 was overstated by the same amount. As a result, Mattel’s net loss and net loss per share were understated by 15% and overstated by 63% respectively. It also found that Mattel had no internal control specifically related to calculating a valuation allowance for that time frame. Additionally, the tax expense error remained uncorrected and the lack of internal control for financial reporting undisclosed until Mattel’s November 2019 restatement.

Securities laws

SEC’s order found that Mattel violated the negligence-based antifraud provisions and the reporting, books and records, and internal controls provisions of the securities laws.

Mattel has neither admitted or denied these findings, but has agreed to a cease-and-desist order and to pay a $3.5m civil penalty.

In accepting Mattel’s settlement offer, the Commission took into account the company’s cooperation with SEC’s investigation and its remediation.

Violated auditor independence rules

In addition to the $109m tax error, the SEC initiated a separate litigation against Joshua Abrahams, a former audit partner at PricewaterhouseCoopers LLP (PwC).

According to the order, the SEC alleged that Abrahams violated numerous professional standards in the Q3 2017 interim review and the 2017 annual audit of Mattel’s financial statements. The order also states that Abrahams failed to verify that the uncorrected $109m error was documented, despite knowing of it, and also failed to inform Mattel’s audit committee about it, including failing to provide prohibited human resource advices.

Abrahams will be scheduled for a public hearing before the Commission to decide if the Enforcement Division has proven the allegations in the order and what, if any, remedial actions are appropriate.

“An auditor’s adherence to professional standards and independence is critical to preserving investors’ trust in a company’s financial statements,” said Alka N. Patel, Associate Director of the Los Angeles Regional Office. “Auditors who advise their clients on who to hire will have an interest in the success of such hires and could therefore be less critical of their effectiveness, all of which undermines the auditor’s independence.”