November 29, 2019

Inside Sealed Air's Balancing Act

Source: Charlotte Business Journal

Sealed Air Corp. has suffered some bumps and bruises since landing in Charlotte three-and-a-half years ago. Now, management must balance the challenges of twin investigations by the Securities and Exchange Commission and a federal grand jury while executing a significant restructuring.

It also faces a challenge from the Internal Revenue Service to a $1.49 billion tax deduction taken in 2014 that could take $3 per share off the company’s value if lost, analysts say. And there are concerns about its 2017 discount sale of Diversey and, now, a shareholder suit accusing the company of fraudulently inflating its value.

To date, Sealed Air has fired one top executive — former CFO William Stiehl — amid the investigations that have now dragged on for more than a year. But the investigations seem to be broadening for the inventor of Bubble Wrap and manufacturer of a number of proprietary, high-end packaging products.

In June 2018, it received its first SEC subpoena for information about tax accounting and financial disclosures. This past May, the SEC subpoenaed the company again, seeking information about its 2014 choice of an auditing firm and that company’s independence. After Sealed Air dismissed Stiehl in June, the U.S. Attorney’s Office in Charlotte served the company with grand-jury subpoenas for information about that firing and the auditor hiring.

The company declined to comment on the investigations or on the shareholder lawsuit filed just this month, stating it does not comment on pending litigation.

The company also declined to say whether it feared any impact on investors or the stock price from the investigations.

Investigations of this sort can have many impacts on a company, says Denis Arnold, Surtman distinguished professor of business ethics at UNC Charlotte. In the worst-case scenario, there could be fines and criminal charges. Regardless, top executives have to prepare for adversity.

Any serious investigation can create uncertainty, and investors hate uncertainty, he says. Typically, a stock suffers, and SEE is trading now closer to its 52-week low than its 52-week high.

Investigations can also sap executive time and attention. Sealed Air concedes in SEC filings: “We cannot predict the outcome or duration of either of those investigations and there can be no guarantee as to the amount of internal and external resources we may need to devote to responding to any further requests we may receive from the SEC and/or the U.S. Attorney’s Office.”

Writing about the SEC investigation earlier this summer, KeyBanc analyst Adam Josephson said while the outcome is uncertain, “there’s no potential upside and only potential downside from that.”

Investigations and shareholder suits are not unheard of, nor necessarily crippling. We’ve seen many examples in the Charlotte region.

Duke Energy Corp. managed a grand-jury probe of its coal-ash operations that ended with the power company pleading guilty to misdemeanor environmental violations and paying significant fines. It also handled regulatory probes into the firing of CEO Bill Johnson within hours of its acquisition of Progress Energy. And it weathered shareholder suits over both.

Wells Fargo & Co. has perhaps fared worse with state, federal and SEC investigations involving fraudulent accounts. A lot of top executives have been replaced and fines have been paid. But it, too, appears to have come through, and lately WFC trading near its 52-week high.

“The key is going to be sharing as much information as possible with employees, customers and key stakeholders to maintain trust,” says Patrick Sweeney, professor of the practice of management at Wake Forest University.

He does not have direct knowledge of Sealed Air’s situation. But, he says, generally a company must cooperate with investigators while providing periodic public updates — with counsel from its lawyers. And it needs to review its procedures and reassert an ethical operating culture. “We want to make sure the ethical boundaries are very clear,” he says. “We want to avoid the perception that the company is acting in questionable ways or possibly breaking the law.”

Sealed Air disclosed its first subpoena in this case in the first quarterly report after receiving it. It has undertaken at least one internal review and has maintained throughout that it is cooperating with both the SEC and the U.S. Attorney’s Office. 

Arnold has no direct knowledge of Sealed Air’s situation. But, he says, there are signs to look for about how well a company is dealing with such legal issues.

He notes the SEC regime for financial reporting is geared toward preventing problems. The ideal process in any kind of violation, he says, involves a company finding the issue on its own and self-reporting. Then, a company is expected to take action, including dismissals. And it should take steps to strengthen its interior compliance regulations to eliminate whatever failures led to the violation.

There is good and bad news for Sealed Air on that count. 

“Firing a C-suite executive is a really good sign,” Arnold says. “Oftentimes, lower level managers take the blame and senior management is protected.”

But there is no indication that Sealed Air discovered the problem itself. And the firing of Stiehl — who has denied wrongdoing and said he will contest the dismissal — came about a year after the SEC investigation started.

Sealed Air concedes the firing was the result of an internal investigation that started only after the SEC issued its second subpoena in May. And, Sealed Air did not dismiss the auditing firm, Ernst & Young, whose independence authorities have questioned, until Aug. 7.

But Sealed Air has not been required to restate any of its past financial results.

That is important, says Salvator Tiano, who follows Sealed Air for Vertical Research Partners. Questions about an auditor’s independence are not unimportant, he says. But the key for investors is the reliability of the financial information.

Whatever happened in the selection process, he says, “if the auditor did the job well and the numbers were correct — and it appears here they were — the investors shouldn’t be concerned.”

The company has not raised the possibility of any restatement of earnings in any of its public filings. And there is no public indication it has made any attempt to claw back any bonuses or incentives to Stiehl or other executives. Sealed Air’s executive contracts allow the company to recoup “compensation based on achievement of financial results that were subsequently restated due to error or misconduct, regardless of whether named executive officer was responsible for the error or misconduct,” the company says in its proxy statement.

In announcing it was letting Ernst & Young go, Sealed Air expressed no dissatisfaction with the audits it had done since 2015. It even offered at least a mild defense of the firm as it announced it was hiring PricewaterhouseCoopers as a replacement.

“EY has reaffirmed to the (Sealed Air) that EY believes there has been no independence violation, and the company has not reached a contrary conclusion,” Sealed Air says in an Aug. 12 SEC filing.

It cited the SEC investigation “along with the Committee’s dissatisfaction with information it learned about the process by which EY was selected” as the reasons it decided to “make this change now to allow for an orderly transition for the audit of the company’s fiscal 2019 consolidated financial statements.” Sealed Air said it wanted “to minimize the risk of disruption that could arise in the event of an unplanned change in independent auditors …in the future.”

Asked whether the investigations could reduce focus on initiatives such as the broad ReInvent SEE restructuring, a spokesman said: “We are making outstanding progress on our ReInvent SEE programs that are aimed at transforming Sealed Air and driving world-class performance and profitable growth for the company.”

Tiano has his doubts about how well the restructuring is going. That is a problem for Sealed Air, he says, as the restructuring has not shown up on the bottom line in any significant way. He does not attribute that to executive distraction from the investigations.

“In the end, you let the lawyers and the legal process hash it out,” he says, adding top executives don’t have to be actively involved.

“Just because there is an SEC investigation, it doesn’t mean it has to relate to a liability,” he says, and even the grand-jury investigation is not necessarily a cause for major concern. “Legal issues affect a lot of companies. There are SEC investigations that have no detrimental effect.”

Tiano sees the company’s relatively weak performance in its key product-care division as more important. It has seen a slow decline in sales with no sign that trend will turn around soon. Overall, he says, Sealed Air’s recent performance has been mediocre.

Investors also have reservations about Sealed Air’s 2017 sale of its Diversey sanitary products division. Sealed Air bought the company in 2011 for $4.3 billion and sold it for $3.2 billion.

Tiano says the pending IRS challenge to the $1.49 billion tax deduction Sealed Air took at the end of 2014 should be a bigger influence on the share price than the SEC investigation.

That related to a settlement Sealed Air made with W.R. Grace & Co. Sealed Air bought Grace’s Cryovac division in 1998. A few years later, when asbestos claims drove Grace into bankruptcy, some claimants filed actions against Sealed Air as Grace’s successor in Cryovac.

As Grace emerged from bankruptcy in 2014, Sealed Air placed $930 million in cash and 18 million shares of its stock into trusts established for the Grace asbestos claimants, taking a $1.49 billion tax deduction.

Tiano says if the IRS wins everything in that challenge, it could require a payment of as much as $500 million from Sealed Air. He says that could cut its stock value by $3 per share.

That would be a significant blow to a stock trading in the high $30s.

There are investors and analysts who think the tax issue may be the ultimate cause of the auditing and financial reporting issues now under investigation for Sealed Air.

Tiano would not comment on where the investigation may have started. The shareholder lawsuit filed Nov. 1 alleges the tax deduction was illegitimate and Ernst & Young was hired to help Sealed Air claim it anyway.

“In late 2014, as the Company was finalizing its accounting treatment for the improper $1.49 billion tax deduction, Sealed Air fired its auditor KPMG LLP … and hired Ernst & Young LLP,” the suit alleges. “As Sealed Air was in the process of switching auditors, it was also engaged in a fraudulent scheme to improperly account for income taxes and provide misleading financial reporting and disclosures to the Company’s investors.”

Stiehl was then the company’s chief accounting officer and controller.

The suit, filed as a potential class action, contends “the fallout from defendants’ misconduct sparked an SEC investigation, a criminal inquiry, the firing of Sealed Air’s CFO ‘for cause,’ and the termination of EY’s engagement due to questions regarding the firm’s lack of independence.”

The SEC and U.S. Attorney have not made public statements on the investigations or their origins. In the first public notice of the SEC investigation in 2018, Sealed Air noted the subpoena sought information “including requests concerning the company’s accounting for income taxes.”

It did not specify any particular tax claim.

The public disclosures do not note whether any specific executives are under investigation. Sealed Air contends its internal investigation implicates Stiehl. The lawsuit names former CFO Carol Lowe and former CEO Jerome Peribere as defendants, claiming they participated in the effort to mislead investors about the legitimacy of the tax deduction and the value of the company. It also names current CEO Ted Doheny, contending the effort to deceive continued through August of last year.

“It’s bad a situation,” WFU’s Sweeney says. “They’ve got to continue to do business and make sure they are supporting the investigation.”

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