Hello. I'm Grant Walstrom, contributing editor to Internal Auditor magazine's fraud department and Senior Manager of Fraud Forensics and Investigations at a DT in Boca Raton, Florida. I'm pleased to introduce this episode of Fraud on the All Things Internal Audit podcast, which provides fictionalized accounts a fraud based on actual events Too close to the sun. Due diligence. Failures leave a company with an array of costly problems after it acquires a solar business.
Part one, setting the world on fire. James Baker, a former roofer based in Austin, Texas, founded Tan Solar in 2018 To capitalize on the green energy trend, tan quickly became one of the largest solar panel system providers in the us. But when Baker learned that federal government subsidies for solar power were expiring, he decided to sell the business.
Baker heard through the grapevine that Summit, HVAC and Plumbing, a publicly traded company that provided service throughout the US was struggling and needed to create a new division that would drive rapid growth. Baker decided to call Summit CEO, Greg Henry about buying Tan Solar, and the two quickly came to an agreement. Despite his executive team's concerns about summit's, lack of experience in the solar industry, Henry instructed his staff to begin the process of purchasing.
Tan Henry was well known on Wall Street for his fast and confident decision making. Summit's. Years of acquisitions and constant growth led Henry to believe he was infallible. So with little due diligence, summit finalized the purchase of Tan Solar for $1 billion. Part two, burning money. After the acquisition summit's Vice President of Operations, Bob Welch was tasked with integrating Tan's operations.
When reviewing Tan's financial records, he learned the company had sold solar systems to customers who financed them through a small banking network. The banks would extend loans to customers and make payments directly to Tan. If a customer defaulted on a loan, the bank would reclaim the payment from Tan Welch discovered the banks were claiming a considerable number of payments from customers who had never made a single payment.
He also learned that Tan had installed thousands of systems without completing the required city and county permits even worse. Welch knew that Tan's acquisition price was based on multiples of annual revenue and that tan booked revenue. Upon completing a system installation, a single solar system was worth about $30,000. Each system installed without a permit represented an overstatement of revenue and acquisition price.
If Summit could not obtain all the permits for the installed systems, it would need to remove them from customer's roofs, which would be tremendously expensive. Welch reported these concerns to CAE Robert Soar. The CAE knew that the overstated revenue could lead to a restatement of earnings violations of US Securities and Exchange Commission rules and potential fines. Welch was considering his next steps when Soar knocked on his office door.
He told Welch he had just received a call from the Georgia State Attorney General's office, which was investigating whether the solar business was using deceptive sales practices. Troubled by the allegation, they began reviewing past regulatory inquiries. To their surprise, 28 states had raised concerns about tan sales practices, and Ohio was threatening criminal charges. Part three, going down in flames.
Welch knew Tan maintained an ethics hotline and had recently learned that it had received hundreds of customer complaints alleging deceptive sales practices. Customers were told that buying a solar system would pay for itself. However, cost savings were actually based on the answers to three questions. What was the customer paying for a kilowatt of electricity? Did the system have an unobstructed view of the sun? How well was the house insulated?
Sales representatives were trained to overstate a customer's cost per kilowatt hour or not adjust their calculation for home shaded by trees. Customers would buy these systems assuming they were saving money, but the actual savings often fell short of the sales pitch. Welch's investigation concluded that Tan had installed hundreds of systems without permits. The cost of removing those systems resulted in a massive financial loss for Summit in its first year of operating the business.
In addition to address complaints about deceptive sales Summit instituted sales practices that disclosed the actual cost and savings. Unfortunately, this revealed that the solar systems were not cost effective for many customers leading to fewer sales. The result Summit closed the solar business laying off thousands of employees. Its stock price lost half of its original value. With Tan closing, the state's dropped their investigations.
Baker returned to his roots acquiring a national roofing company, his first customer summit. After all, someone had to remove the solar systems from people's homes and fix their damaged roofs. This has been the All Things internal audit fraud podcast, fictionalized accounts based on actual events brought to you by the Institute of Internal Auditors, I I A members can access the full story in this month's issue of Internal Audit Magazine, including bonus materials on lessons learned.
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