SEC Issues Accounting & Auditing Enforcement Order Involving Interface, Gregory J. Bauer and Patrick C. Lynch

WASHINGTON, Sept. 29 -- The Securities and Exchange Commission's Accounting and Auditing Enforcement issued the following order (No. 4175) involving Interface, Gregory J. Bauer and Patrick C. Lynch:

In the Matter of INTERFACE, INC., GREGORY J. BAUER, CPA, and PATRICK C. LYNCH, CPA, Respondents.

ORDER INSTITUTING PUBLIC ADMINISTRATIVE AND CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, SECTIONS 4C AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934, AND RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER

I.

The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative and cease-and-desist proceedings be, and hereby are, instituted against Interface, Inc. ("Interface") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), against Gregory J. Bauer, CPA ("Bauer"), pursuant to Section 8A of the Securities Act, Sections 4C/1 and 21C of the Exchange Act, and Rule 102(e)(1)(iii) of the Commission's Rules of Practice,/2 and against Patrick C. Lynch, CPA ("Lynch") pursuant to Sections 4C and 21C of the Exchange Act and Rule 102(e)(1)(iii) of the Commission's Rules of Practice.

II.

In anticipation of the institution of these proceedings, Interface, Bauer, and Lynch (collectively "Respondents") have submitted Offers of Settlement (the "Offers") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and the subject matter of these proceedings, which are admitted, and except as provided herein in Section V, Respondents consent to the entry of this Order Instituting Public Administrative and Cease-And-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Sections 4C and 21C of the Securities Exchange Act of 1934, and Rule 102(e) of the Commission's Rules of Practice, Making Findings, and Imposing Remedial Sanctions and a Cease-And-Desist Order ("Order"), as set forth below.

III.

On the basis of this Order and Respondents' Offers, the Commission finds/3 that:

SUMMARY

1. From the second quarter of 2015 through the second quarter of 2016, Interface, a global designer and manufacturer of modular carpet, reported earnings per share ("EPS") that did not accurately reflect the company's underlying performance. During these five consecutive financial quarters, Interface's then-Corporate Controller, Bauer, directed or otherwise caused his subordinates to book unsupported, manual accounting adjustments to Interface's management bonus accruals, expenses related to a key independent consultant ("Consultant"), and stock based compensation. These adjustments did not comply with generally accepted accounting principles ("GAAP") and artificially inflated Interface's income and EPS, which resulted in Interface meeting or beating consensus estimates for EPS and showing earnings growth. Interface's then-Chief Financial Officer ("CFO"), Lynch, also caused Bauer to direct entries in two quarters that lacked support and did not comply with GAAP. Bauer and Lynch were able to direct or cause these improper adjustments because Interface failed to have sufficient accounting controls or procedures in place to prevent unsupported, manual, period end, journal entries. Interface lacked critical journal entry controls and Bauer's subordinate accountants were not knowledgeable in GAAP.

2. The adjustments and misstatements were also material to Interface's financial statements and caused Interface to make false disclosures in public filings, press releases, and earnings calls about its actual EPS results, its earnings growth, and its pattern of meeting or beating consensus analyst estimates. Had Lynch and Bauer ensured the financial statements complied with GAAP, Interface's reported earnings would have been more volatile than reported, and in two quarters in which it reported meets of analyst consensus EPS, Interface would have in fact missed the consensus estimates. Consequently, Interface's conduct was materially misleading to investors in violation of the federal securities laws.

RESPONDENTS

3. Interface is a Georgia corporation with its principal place of business located in Atlanta, GA. The company's shares are registered with the Commission pursuant to Section 12(b) of the Exchange Act and trades on the NASDAQ Exchange under the symbol "TILE." Interface files periodic reports, including Forms 10-K and 10-Q, with the Commission pursuant to Section 13(a) of the Exchange Act and related rules thereunder.

4. Bauer, age 44, resides in Smyrna, GA, and is a CPA licensed in the State of Georgia. Bauer was Interface's Vice President and Controller from 2011 through October 2017, at which time he was promoted to the position of Vice President of Finance and Chief Accounting Officer. Interface placed Bauer on paid administrative leave on April 23, 2019, and terminated his employment on July 15, 2020.

5. Lynch, age 50, resides in Marietta, GA and is a CPA licensed in the State of Georgia. His license lapsed in approximately 2004. Lynch was Interface's CFO from June 2001 to November 2016, at which time he left Interface to be the CFO of another company. From May 2019 to the present, Lynch has served as the CFO of a privately-held consolidating subsidiary of a public holding company.

FACTS

Second Quarter of 2015

6. In Q2 2015, Interface reported EPS of $0.33 and its earnings release stated that it had "finished with earnings per share that tied our all-time record in the fourth quarter of 2007." In truth, Interface did not achieve record EPS in Q2 2015 because it understated its actual expenses for management bonuses by $1.58 million, which in turn inflated its pre-tax income by 5% and its EPS by $0.02.

7. In early June 2015, after learning that Interface was required to pay an unexpected $725,000 death benefit, Bauer directed a $500,000 reduction to the management bonus accrual. Bauer's contemporaneous instruction stated that decreasing the bonus accrual would limit to about "a 250k hit" the net income impact of the unexpected death benefit expense.

8. Bauer's decision to reduce the management bonus accrual in order to offset the surprise death benefit expense did not comply with GAAP.

9. Interface paid non-discretionary management bonuses based on the achievement of established targets for operating income before incentives ("OIBI") and cash flow. If Interface met the stated "goal" for those targets, management would receive 100% of their bonus potential. If Interface exceeded the goal, management would receive up to a maximum, 150%, of their bonus potential depending on the amount by which the goal was exceeded.

10. The internal financial forecasts reviewed by Lynch and Bauer and provided to the board of directors in Lynch's monthly and quarterly board reports reflected Interface's best estimates for probable OIBI and cash flow. Throughout the relevant period, Lynch and Bauer understood the formulas for calculating the bonus amount. During the quarterly closing process, they both reviewed the bonus accrual and together determined whether to book any adjustments to it.

11. At the time that Bauer improperly reduced the bonus accrual by $500,000, Interface's best estimate was that annual bonuses at levels far greater than 100% would be paid. Reducing the accrual by $500,000, however, caused Interface's accrual level to fall far below the 100% level.

12. During the closing process for the second quarter, when Interface was on track to report an all-time record EPS of $0.33, Bauer kept the accrual level at well below 100% despite the best estimates that showed a maximum, 150%, annual bonus was probable to be paid. As CFO, Lynch should have known that the bonus accrual level did not match the levels indicated by the company's best estimates for OIBI and cash flows, but took no steps to ensure its accuracy.

13. As a result and in total, Interface's management bonus accrual and related expenses for Q2 2015 were understated by approximately $1.58 million, or 5% of pre-tax income, and its EPS was falsely inflated by $0.02.

Third Quarter of 2015

14. In Q3 2015, Interface publicly reported that it had met consensus estimates for EPS of $0.31, reflecting a continued pattern of meeting or beating analyst estimates for four consecutive quarters. In truth, Lynch and Bauer had directed unsupported accounting entries and otherwise misstated expenses, which inflated Interface's pre-tax income by 12%, or a total of over $3.12 million. Rather than report a meet of consensus EPS estimates, Interface should have reported a $0.04 miss.

15. The first set of improper entries in Q3 2015 concerned Interface's accounting for a collateral split dollar life insurance arrangement that Interface had with its independent Consultant. Under this arrangement, Interface agreed to pay for the annual premiums for a whole life insurance policy owned by the Consultant. The Consultant, in turn, agreed to repay those premiums to Interface in or around May 2016. As collateral for the premiums Interface paid, the Consultant assigned to Interface the cash surrender value ("CSV") of his policy up to the amount of the premiums paid. Any amount of the policy's CSV in excess of the premiums paid belonged to the Consultant outright, with certain defined exceptions that did not and were not probable to occur. Based on the plain language of Interface's agreement with the Consultant, the value of the CSV as reflected on Interface's books should have never exceeded the amount of unreimbursed premiums paid. Yet Interface historically recorded the full value of the CSV on its balance sheet.

16. During Q3 2015, Bauer learned that the asset would need to be written down by the amount recognized in excess of the premiums paid, $871,140. He also learned that the Consultant would likely reimburse Interface for the premiums paid in May 2016. Yet Bauer did not immediately write down the asset. Contrary to GAAP, Bauer instead began a process of bleeding the value down in equal increments of $87,114 over ten months. By the end of the quarter, Bauer had recorded just $174,228 against the $871,140 excess valuation. As a result, Interface's CSV asset and associated income were inflated by approximately $697,000 (the difference between $871,140 and $174,228). This error, standing alone, increased Interface's EPS by almost $0.01, and, if it had been recorded properly, would have changed Interface's reported meet of consensus estimates to a miss.

17. The second set of improper entries in Q3 2015 concerned Interface's stock based compensation and management bonus. In October 2015, Interface's finance department prepared the first draft of Interface's Q3 2015 consolidated internal financial statements, which showed that actual EPS for the quarter was $0.02 shy of the $0.31 analyst consensus estimate. Bauer unreasonably directed his staff to book adjustments to achieve "a pick up of about 740k," and later that same day, Bauer and his staff improperly reduced the expense for a stock grant by $628,000. The adjustment did not comply with GAAP and artificially inflated Interface's EPS by almost $0.01. Standing alone, correcting this error would have changed Interface's reported meet of consensus estimates to a miss.

18. On the same day that Bauer reduced the stock grant expense, he also directed his staff to increase the management bonus accrual by only $100,000 even though Interface's best estimates for OIBI and cash flows indicated that the management bonus liability was under-accrued by approximately $1.67 million. The stated justification for the entry was to "correct bonus accrual," but the adjustment still left the bonus accrual - and associated expenses - understated by approximately $1.57 million in Q3 2015. As CFO, Lynch should have known that the bonus accrual level did not match the levels indicated by the company's best estimates for OIBI and cash flows, but took no steps to ensure its accuracy. As a result, Interface avoided reporting a $0.016 reduction to its EPS for the quarter and a miss of consensus estimates.

19. A third and final set of entries concerned the annual bonus that Interface was obligated by contract to pay its Consultant. Updated Q3 2015 internal financial statements reflected the adjustments described in the forgoing paragraphs, but still showed actual EPS to be just shy of consensus estimates. Lynch and Bauer subsequently and unreasonably directed the full reversal of the $225,000 that had been accrued to date for the Consultant's bonus. This last-minute manual adjustment did not comply with GAAP. The Consultant's bonus was paid pro rata, and thus, it was incorrect to reverse the full (or any) amount. This error artificially boosted Interface's EPS by $0.002 - just enough for Interface to round up to $0.31 and report a meet of analyst consensus EPS estimates.

20. In total, Interface's income for Q3 2015 was overstated by approximately $3.12 million, or 12% of pre-tax income, and its EPS was inflated by $0.04.

Fourth Quarter of 2015

21. In Q4 2015, Interface reported a quarterly EPS of $0.28 and an annual EPS of $1.10, which represented a record for Interface and a $0.02 beat of consensus estimates for the year. While the quarter's EPS was a $0.01 miss of consensus, it was just enough to allow Interface to report a $0.02 beat of estimates for the year, and Interface's earnings release highlighted that the "fourth quarter rounded out a phenomenal year in which Interface posted all-time records for net income and earnings per share." In truth, however, Interface's results were artificially inflated by Bauer's adjustments to the Consultant's bonus, the CSV, and the management bonus. Had the financial statements complied with GAAP at the end of 2015, Interface would have reported a $0.03 miss of the consensus for the quarter, and instead of beating analyst consensus estimates for the year, Interface would have reported only a meet.

22. After the third quarter's books had closed and the company reported that it met analyst consensus EPS estimates, Bauer resumed the monthly accrual for the Consultant's bonus. By year end, Interface had accrued a balance of only $75,000 even though the Consultant was due his full $300,000 bonus. However, neither Lynch nor Bauer directed the $225,000 increase required to make up for the reversal in the previous quarter.

23. Bauer also directed unsupported adjustments to the Consultant's CSV. During the closing process for the quarter, Bauer directed his financial manager to "reverse half...for now" of the approximately $436,000 they had recorded by that time to write down the CSV asset as part of their improper bleed down process. This adjustment did not comply with GAAP and served only to artificially reduce expense by approximately $218,000. A few days later, Bauer also stopped the monthly bleed-down. As a result, Interface overstated the CSV asset and associated income by approximately $653,000, which in turn inflated its quarter-end and year-end EPS by $0.01.

24. Less than an hour after he had directed the $218,000 CSV expense reduction, Bauer also directed that a $350,000 balance he had in another liability account be used to decrease expense generally by $150,000 and increase the management bonus accrual by $200,000 without any corresponding increase to bonus expense. Bauer's adjustments did not comply with GAAP, as Interface's internal financial statements and best estimates at the time made clear that the bonus was under-accrued by approximately $949,000. As CFO, Lynch also should have known that the bonus accrual level did not match the levels indicated by the company's best estimates for OIBI and cash flows, but took no steps to ensure its accuracy. By increasing the accrual by only $200,000, Interface's bonus accrual and related expenses remained understated at year end by approximately $749,000, which in turn inflated its quarter-end and year-end EPS by $0.01.

25. In total, Bauer's improper adjustments and Lynch's failure to ensure the bonus accruals were accurate caused Interface to overstate income by a total of $1.63 million, or 7% of the quarter's pre-tax income. They also caused Interface's EPS to be inflated by $0.02. In reality, Interface should have reported EPS of $0.26 for the quarter and $1.08 for the year.

First Quarter of 2016

26. In Q1 2016, Interface reported an EPS of $0.20, meeting consensus estimates and representing a quarter-over-quarter increase of $0.01. However, these results were inflated because Lynch and Bauer had directed unsupported adjustments to the bonus accruals and otherwise caused Interface's stock based compensation expense to be understated. Bauer also directed unsupported and improper adjustments to the CSV. Given these adjustments, rather than report growth and a meet of consensus, Interface should have reported an EPS of just $0.17 - a $0.02 quarter-over-quarter decline and a $0.03 miss of consensus.

27. During the Q1 2016 closing process, when weak sales weighed down Interface's performance, Bauer directed that the remaining $218,000 CSV write-down balance be reversed in full. That same day, Lynch and Bauer directed their staff to reverse the entire $740,000 balance in the management bonus accrual even though Interface's best estimates for OIBI and cash flow suggested that an accrual of approximately $1 million was necessary in the quarter. Together, these adjustments - which did not comply with GAAP - resulted in an immediate $958,000 increase to income and a $0.01 increase in EPS.

28. A few days later, and after discussing with Lynch how the company would "articulate to [the] street" its declining sales trends, Bauer directed his financial manager to increase the CSV asset's value another $210,000, stating simply, "Think we are gonna need that cash surrender value...." Given this asset increase and Interface's intervening payment of another premium, Bauer continued to overstate the CSV asset, now by a total of $994,000. Like the other entries Bauer directed, this CSV adjustment did not comply with GAAP, increased EPS, and enabled Interface to report a $0.20 meet of consensus estimates.

29. Lynch and Bauer also caused Interface to understate the company's stock based compensation expense in Q1 2016, allowing the company to report an EPS meet. Although the internal financial statements and best estimates for annual EPS plus dividends ("EPSD") showed it was probable that one of the company's stock grants would vest in full by the end of the year, Interface did not record any associated increase in expense. As CFO and Controller, respectively, Lynch and Bauer should have known that the stock expense accrual level did not match the levels indicated by the company's best estimates for EPSD, but took no steps to ensure its accuracy. As a result, Interface's stock expense for the quarter was understated by approximately $387,000.

30. In total, Interface's income for Q1 2016 was overstated by approximately $2.43 million, or 15% of pre-tax income, and its EPS was inflated by $0.03.

Second Quarter of 2016

31. In Q2 2016, Interface reported EPS of $0.32, which Interface and its senior management described in the accompanying press release and earnings call as "strong," the "second best quarterly earnings ever," and "just a penny short of the all-time record." In truth, Bauer had directed improper and unsupported accounting entries and otherwise improperly misstated expenses, which inflated Interface's pre-tax income by 7%, or approximately $1.9 million. Interface's true EPS of $0.30 actually reflected a $0.03 quarter-over-quarter and $0.01 year-to-date decline in earnings.

32. The first set of improper entries that Bauer directed concerned the CSV. The day after Interface reported its Q1 2016 meet of analyst estimates for EPS, Bauer once again began bleeding down the CSV asset. As expected, in May 2016, the Consultant fully reimbursed Interface for the premiums paid - leaving Interface with no claim to the CSV at all. Instead of reducing the full value of the CSV asset, Bauer left $179,000 on Interface's books. This error alone, if corrected at the time, would have cost Interface $0.01 in EPS due to rounding.

33. The second set of improper entries concerned the management bonus accrual. By quarter end, Interface's bonus accrual was at an approximate 50% achievement level given the improper reversal at the end of Q1 2016. The company's internal financial statements and best estimates for OIBI and cash flows at the end of Q2 2016 showed a probable bonus achievement of approximately 69% - indicating that Interface needed to increase expense to meet the expected liability. Nevertheless, Bauer directed a $400,000 reduction in bonus expense, which increased reported EPS by one penny with rounding. As CFO, Lynch should have known that the bonus accrual level did not match the levels indicated by the company's best estimates for OIBI and cash flows, but took no steps to ensure its accuracy. As a result of their conduct, Interface's management bonus accrual and related expenses were understated by a total of $951,000 in Q2 2016, which inflated EPS by $0.01.

34. Lynch and Bauer also caused Interface to understate its stock based compensation expense in Q2 2016, which enabled it to report a $0.32 EPS. As in the prior quarter, the internal financial statements and best estimates for EPSD showed it was probable that one of the company's stock grants would vest in full by the end of the year. Nevertheless, Interface did not record the associated increase in expense, and Interface's stock expense was therefore understated by a cumulative total of $774,000 in Q2 2016. As CFO and Controller, respectively, Lynch and Bauer should have known that the stock expense accrual level did not match the levels indicated by the company's best estimates for EPSD, but took no steps to ensure its accuracy. Correcting this error at the time would have cost Interface almost another $0.01.

35. In total, Interface's income for Q2 2016 was overstated by approximately $1.9 million, or 7% of pre-tax income, and its EPS was inflated by $0.02.

Interface Lacked Accurate Books and Records and Sufficient Internal Accounting Controls

36. These adjustments to Interface's expenses, which inflated EPS quarter after quarter, were made in part because Interface lacked sufficient internal accounting controls over (a) significant recurring accruals subject to management estimate including incentives and stock based compensation, (b) journal entries, and (c) period-end adjustments made during the closing process. Interface did not require, for example, corporate level accounting entries to have supporting documentation, and corporate finance staff regularly recorded manual adjustments with nothing more than an email or oral directive. In addition, Bauer's direct reports did not analyze or consider the propriety of the entries he directed, and Interface's Internal Audit function did not perform procedures sufficient to ensure adjustments directed by Lynch and Bauer had support and complied with GAAP.

37. As a result, Interface's internal accounting controls were not designed or maintained to provide reasonable assurance that Interface's financial statements would be presented in conformity with GAAP. Interface's books, records and accounts also did not accurately and fairly reflect, in reasonable detail, Interface's transactions and disposition of assets.

Conduct During the Investigation

38. Between November 2017 and March 2018, Interface employees caused Interface to produce documents in response to Commission investigative requests that were suggestive of contemporaneous support for journal entries that, in truth, did not exist at the time the entries were recorded. One of these employees also certified as contemporaneous business records certain documents that, in fact, had been modified after the investigation began. These shortcomings had the effect of impeding the staff's investigation.

39. When Interface learned of these issues, Interface promptly informed the Staff, conducted an internal review, took disciplinary and remedial measures, and reported its findings.

Sales of Interface Stock

40. Interface awarded restricted stock grants to certain executives and management under Interface's Omnibus Stock Incentive Plan. On July 30, 2015, Interface filed a Form S-8, registering an additional $4.9 million of shares at a maximum offering price per share of $23.46. The Form S-8 incorporated by reference all of Interface's subsequent annual and quarterly reports filed thereafter until termination of the offering, including Interface's 2015 Form 10-K and its 2015 and 2016 Forms 10-Q filed during the relevant period.

41. Lynch received Interface stock under the Omnibus Stock Incentive Plan and, pursuant to a 10b5-1 plan executed on March 14, 2016, sold a total of 7,500 shares for proceeds of $134,861 between March 18, 2016, and July 28, 2016.

42. Bauer also received Interface stock under the Omnibus Stock Incentive Plan. On March 10, 2016, he sold 8,270 shares of Interface stock for total proceeds of $138,283.

The complete text of the document is available at: https://www.sec.gov/litigation/admin/2020/33-10854.pdf

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Footnotes:

1/ Section 4C provides, in relevant part, that:

The Commission may censure any person, or deny, temporarily or permanently, to any person the privilege of appearing or practicing before the Commission in any way, if that person is found . . . (1) not to possess the requisite qualifications to represent others; (2) to be lacking in character or integrity, or to have engaged in unethical or improper professional conduct; or (3) to have willfully violated, or willfully aided and abetted the violation of, any provision of the securities laws or the rules and regulations issued thereunder.

2/ Rule 102(e)(1)(iii) provides, in pertinent part, that:

The Commission may . . . deny, temporarily or permanently, the privilege of appearing or practicing before it . . . to any person who is found ... to have willfully violated, or willfully aided and abetted the violation of any provision of the Federal securities laws or the rules and regulations thereunder.

3/ The findings herein are made pursuant to Respondents' Offers of Settlement and are not binding on any other person or entity in this or any other proceeding.