Revenue Recognition Frauds for Lawyers: Round Tripping

Revenue recognition is a central accounting principle that dictates when a company can recognise income from sales. Revenue is often used by internal and external stakeholders as a metric to determine a company’s worth, however, if revenue recognition is deliberately manipulated, the fraud can carry financial, reputational and legal consequences. This article is part of a series explaining some of the most common forms of revenue recognition fraud.  For an overview of revenue recognition and the potential consequences of its abuse, please see here.

Revenue ‘round tripping’, also known as ‘circular trading’ or ‘Lazy Susans’^[1], refers to a series of unethical sales or investment transactions through which goods or services from one company are passed to a third party, only to be resold to the original company at the same, or approximately the same price. They are distinct from properly disclosed open and closed transactions such as sale and return contracts or swap trades because the commercial nature of the transaction is deliberately obscured.

How it works

Unethical round tripping transactions can manifest in several ways within a company’s accounts.  The most common round tripping examples connected to revenue tend to either show artificial sales volume, or increased sale value based on manipulated market demand.  

Corporate round tripping: Goods/services are sold from Company A to Company B, and the same or equivalent goods/services are then re-sold by Company B, back to Company A. Both companies record trading activity, and sales revenue despite neither having received any genuine economic benefit.  The goods/services need not be identical so that the supply of goods by Company A to Company B may be matched to the sale of services or other goods received from Company B, although typically goods will be identical where services are matched on value only.

Round trip trading: (‘churning’ or ‘wash trades’): Traders purchase and sell the same security repeatedly with the purpose of artificially inflating trading volumes and creating an impression of high market demand.

Round tripping has been used as a fraudulent revenue recognition scheme for decades.  

• In 2004, Qwest Communications (US – 2002-2004) was fined $250 million and consented to the judgment finding that it had used “swap” contracts to buy and sell network/fibre capacity with other companies to artificially inflate its reported revenue by $3.8 billion.  
• Investigations into the collapse of Enron (US - 2001) identified that Enron used round tripping transactions to augment its recorded “mark-to-market” revenue figures, using arrangements with other energy companies to sell and re-purchase the same commodity assets to drive the appearance of high market demand (wash trades) and rapid revenue growth.
• In 2001, Time Warner (US – 2001-2005) consented to pay a civil penalty of $300m and to restate its accounts to remove $690m of revenue connected to its alleged participation in round tripping transactions recording revenue from online advertising placed by a network of companies (including Homestore.com) using funds originating from Time Warner, transferred to them as overpayments, waived discounts, legal claim settlements and referral schemes.

Round tripping has continued in some of the largest and most publicised frauds in recent years.

• The Wirecard collapse (Germany - 2020) was triggered in part by funds from the parent entity being transferred to a third party, before being returned, as apparent sales revenue within a subsidiary business.
• The first nine months’ revenue of eFishery (Indonesia – 2024) was overstated by $600 million, approximately 75% of its total revenue, by recording transactions through shell companies and undisclosed related parties.
• Investigations continue into allegations reported by short seller Culper Research, that Zeta Global Holdings (US - 2024) artificially inflated its revenues through “two-way contracts’ with third parties.  Although the company has denied any wrongdoing, the share price dropped by 37% when the allegations were revealed and several class action lawsuits have been filed.

Consequences of round tripping

Specific accounting regulations vary by jurisdiction, but financial statements should show a true and fair view of a company’s financial performance across the reporting period. In doing so, the accounts should reflect the ‘commercial substance’, i.e. genuine economic impact of the trading activity, rather than the pure legal form.

Round tripping obscures the identification of true commercial substance leading to the preparation of fraudulent financial statements that deceive stakeholders about revenue and investment performance. These false financial statements are liable to investigation by regulatory and/or law enforcement authorities as well as exposing the company, its agents and representatives to civil action by others affected by the misstatement.

It is also common for round tripping to facilitate, conceal or augment other types of fraud, which can heighten regulatory scrutiny and potentially result in incremental penalties and enforcement actions.  For example, the circular nature of round tripping transactions makes it complex to identify and trace back the original revenue source, making it a common technique used to layer the proceeds of crime (Money Laundering).  Also, some round tripping transactions provide a commercial incentive or margin to the third party that may be used as a bribe or kickback to secure that third party’s involvement in the round tripping scheme (Corruption).  And companies may expose themselves to the risk of personal enrichment schemes by staff or investors if a sales agent is paid a commission on the circular sale, or if an investor benefits from an artificially high share price/dividend calculated from overstated revenue amounts.

The financial, reputational and, in some cases, criminal ramifications for a company that participates in round tripping can therefore be diverse, complex and long running.  As well as the fines referenced in the examples above, the conduct also has implications for the individuals who perpetrate the fraud.  

• A former executive at Qwest Communications agreed to pay $2.1 million in civil charges and was barred from acting as an officer or director of a public company for 5 years.  
• The ex-CEO of Homestore agreed to pay $11.9m for his participation in the Time Warner round tripping scheme, and was sentenced on appeal to 54 months in federal prison.  Three Time Warner executives settled criminal charges without admitting or denying the allegations and were subjected to considerable personal fines.  

Red flags of round tripping

The following red flags are indicative of potential round tripping and will likely warrant independent forensic examination to gain a better understanding of the transactions’ cause and rationale:

• Concurrent equal and opposite sale and purchase transactions with the same entity or group of entities.
• Revenue growth significantly outpacing industry peers or historical trends and often not supported by increased overall cash in-flows.  
• Cashflows in general may also be misaligned with revenue and cost/expense trends where companies move cash between accounts and related entities to provide the appearance of legitimate business activity.
• Unusually consistent revenue growth, or spikes in revenue towards the end of a reporting period, i.e. out of sync with the seasonal or other fluctuations in the market.
• Increase in sales without a commensurate uptick in amounts receivable, i.e. amounts owed by customers. Companies that experience a legitimate growth in sales will typically observe an increase in accounts receivable. However, in round tripping, it is common to attempt to conceal the transaction substance by netting the receivables balances against the corresponding liability, i.e. amount owed to the supplier.
• Inventory maintained at artificially high levels to support fictitious sales volumes used to create an artificial impression of demand.
• Low gross margins where companies buy and sell at the same price and therefore lose the opportunity to take a profit margin on the goods or services subject to round tripping. In some cases, the goods or services may even be supplied at a loss after accounting for commercial incentives provided to other parties within the round tripping scheme.  
• Unusual levels of trading activity with industry peers and competitors.
• Purchase of companies formerly engaged as external distributors and which hold company stock, used as a means to repurchase the company’s previously sold inventory.
• Group companies recording the highest revenue in jurisdictions with least stringent regulatory environment.
• High volume of related party transactions.

Such red flags can be identified if companies implement counter-fraud controls that consider how best to identify and address the risk of round tripping based on the company’s risk assessment.

The nuances of round tripping investigations

In the event of allegations or concerns about round tripping, companies can minimise the harm to all stakeholders by acting swiftly to capture and secure contemporaneous records.  These records will support the investigative process as well as informing any required remediation, and/or representations to regulatory bodies. The nature of this information will be different in every case but will likely include:

• Sales data – for analysis of sales patterns, revenue and receivables, customer contracts and work orders, as well as inventory levels and cash flow.
• Contracts with customers, including details of Purchase Orders and Work Orders.
• Accounting data and subledger balances – for comparison of sales and purchase transactions with third parties that are both customers of and vendors to the company.
• Related party transaction details – for assessment of transparency and commercial substance.
• Emails and shared drive/cloud storage data – for review of internal and external records and communications related to potential round tripping and/or arrangements to reacquire products sold.
• First person testimony – interviews with sales executives, finance teams, and (if possible) customers to explain the process used to perpetrate round tripping transactions and its intended purpose or effect.

In summary:

Round tripping is a long-used scheme to artificially overstate revenue. The impact of such frauds on company stakeholders can be significant and wide reaching. It remains essential for gatekeepers to be aware of warning flags and take steps to immediately address suspected suspicious activity and detect the scope of any wrongdoing and prevent further harm.  However, the competitive pressures on companies to, achieve sales and meet growth targets means that round tripping fraud is highly likely to continue as a feature of fraudulent accounting for many years to come.