Securities and Exchange Commission Hits Staffing Firm with Substantial Fine for Lacking Adequate Sales Tax Controls

In perhaps a cautionary tale for public companies, the U.S. Securities and Exchange Commission (SEC) has recently levied a $200,000 fine against a professional staffing firm for failing to maintain appropriate controls relating to its sales tax responsibilities. Matter of Hudson Highland Group, Inc., U.S. Securities and Exchange Commission, Admin. Proceeding File No. 3-14182 (January 10, 2011). The company accepted the fine as part of a settlement agreement.

Hudson Highland Group, Inc. (“Hudson”) provides professional staffing and talent management services worldwide. The company was spun off from Monster Worldwide in March 2003. From the time of its spin-off until January 2007, Hudson failed to consistently collect sales taxes from its customers and remit them to the appropriate state and local taxing jurisdictions.

According to the SEC, the company failed to collect and remit sales taxes as required because its accounting software was inadequate. The tax rates and the types of Hudson services that were taxable varied by jurisdiction. The company’s software, however, was incapable of automatically applying these variables in calculating the taxes owed. In addition, Hudson’s staffing contracts were frequently executed with customers located in one locality for work to be performed in one or more other jurisdictions. Although the taxes were generally based on where the work was performed, Hudson’s accounting software did not track this information. Moreover, Hudson did not adequately monitor which customers had “direct pay” permits, or which customers were eligible for special exemptions in a given jurisdiction.

In April 2004, Hudson hired a Big Four accounting firm to assist the company in determining its liabilities and to help the company comply with the sales tax laws. However, the accounting firm did not make meaningful progress on this effort because of high staff turnover at Hudson, which hindered the firm’s ability to obtain necessary documents and interfered with Hudson’s implementation of a new PeopleSoft accounting and management reporting system.

In November 2005, a pending sales tax audit prompted Hudson to assign its tax manager to provide an estimate of the company’s sales tax liabilities and to implement an effective process for tracking its sales tax obligations. The manager was challenged in this undertaking because Hudson’s records were incomplete, requiring the manager to manually reconstruct the sales data required to calculate the taxes owed. And, although Hudson hired an additional person in 2006 to work exclusively on quantifying its sales tax exposure and developing systems to ensure timely and accurate payments of sales taxes, the manual system he developed was not fully implemented for several months. From its spin-off in 2003 until January 2007, Hudson was thus unable to calculate the amount of sales taxes it owed without manual intervention.

The federal Securities Exchange Act of 1934 requires all reporting companies to devise and maintain systems of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles. This law likewise requires reporting companies to make and keep books and records that, in reasonable detail, accurately and fairly reflect their corporate transactions.

The SEC found that Hudson failed to satisfy these requirements in that, as a consequence of its inadequate internal controls, the company’s books and records did not accurately reflect its tax liabilities. The SEC determined that sanctions were, therefore, appropriate and ordered a $200,000 penalty, which Hudson agreed to in settlement of the enforcement proceeding.