What Impact Will Investigation Into Under Armour’s Accounting Have on Athletes it Sponsors?

Major brands have cut ties with athletes long before accusations are proven. But what happens when a company is accused of wrongdoing?

When an athlete’s image is tarnished by controversy, endorsed companies explore whether they can, and should, terminate the relationship. After all, a company doesn’t want to be associated with—let alone pay—an athlete whom the public no longer admires.

As we’ve seen, fans can swiftly turn on athletes who are accused of wrongful acts, be it organizing a dogfighting ring, committing serial adultery or embellishing a gas station robbery while in Rio de Janeiro. Athletes stained by allegations stand to lose millions of dollars if companies they endorse cut ties.

A newly reported federal investigation into Under Armour’s accounting practices flips this discussion. Should athletes who have invested their professional reputations in a company suspected of possible wrongdoing explore whether they ought to cut ties?

According to The Wall Street Journal and The New York Times, the U.S. Justice Department and the U.S. Securities and Exchange Commission are probing whether Under Armour engaged in fraudulent accounting practices. The probe began in 2017, when federal authorities requested records from the Baltimore-based sportswear maker.

The chief area of governmental interest is the manner in which Under Armour has publicly reported sales figures and accompanying expenses. Under Armour, whose CEO, Kevin Plank, plans to step down by the end of the year, maintains that it has engaged in lawful accounting practices. The company also asserts that it is fully cooperating with the authorities.

Tom Brady, Stephen Curry, Lindsey Vonn, Joel Embiid, Brianna Cope and Michael Phelps are among the high-profile athletes whom Under Armour has signed. As explained below, these stars have reason to monitor the trajectory of the federal investigation and assess how it might impact their personal brands.

A brief primer on accounting fraud and potential legal consequences

Whenever the Justice Department and SEC investigate a company for accounting fraud, that company—and its executives—have considerable reason to worry.

Accounting fraud can occur when a publicly traded company falsifies earning statements, thereby misleading investors as to the company’s health and prognosis. One recurring type of fraud is the reporting of revenue before “generally accepted accounting principles” (GAAP) considers it realized and earned.

For instance, law-breaking companies have been shown to “hold the books open.” This phrase refers to secretly extending the reporting period so that revenue which will be earned in future periods is counted as earned during the current period. A similar form of fraud is to delay the reporting of current expenses to future reports. Either mechanism “cooks the books.”

Companies have also been accused of fraudulently “smoothing” the reporting of income—both up and down—in quarterly reports. They do so to falsely suggest a consistent and stable performance. No matter its design, accounting fraud is usually conceived to meet or exceed analysts’ expectations. That, in turn, signals to investors that the company is vigorous and deserving of their money.

Accounting fraud can lead to federal criminal charges brought against company executives, including the chief operating officer, chief financial officer and chief accounting officer. These executives typically have control over financial statements and are thus considered responsible.

The Justice Department relies on several federal laws to bring accounting fraud charges. Among them are the Securities Act of 1933, which plays an instrumental role in government oversight over the buying and selling of stocks, and the Sarbanes-Oxley Act of 2002, which makes it a crime for corporate officers to knowingly certify false financial statements. Specific charges can include fraud, conspiracy, and filing false statements and false disclosures with the SEC. The government’s overarching goal is to ensure that investors can trust financial statements. If those statements are instead rife with lies and exaggerations, investors would be less willing to partake in transactions, thereby damaging the economy.

In addition to criminal charges, civil complaints for fraud and related misconduct can be brought. To that end, the SEC often seeks court orders to stop continuing violations of securities law. The agency also typically requests repayment of ill-gotten gains and sometimes imposes civil penalties on company executives and companies themselves.

Accounting fraud investigations frequently arise because a whistleblower, who is someone willing to expose wrongdoing at the potential risk of losing their career or being sued, comes forward. Resulting cases also often involve plea deals, with company executives agreeing to plead guilty in exchange for lighter punishments. In turn, those executives turn over all incriminating emails and other evidence, and pledge to testify against others.

Morals clauses in endorsement deals and company impatience

It’s worth noting the obvious: an investigation into possible wrongdoing doesn’t mean that wrongdoing occurred or that any wrongdoing will be discovered. At this time, no accounting fraud charges or civil claims have been brought against Under Armour. The same is true of Under Armour’s current and former executives. It’s possible that the federal investigation will come and go and the company will be cleared.

Yet when an athlete is linked to possible wrongdoing, companies often don’t wait for accusations to be proven or discredited. Companies sometimes cut bait when the going gets tough.

To that end, endorsement deals normally contain “morals clauses”. These clauses allow a company to cut ties with an athlete who is merely suspected of misconduct. The company can do so without paying the remainder of the contract.

Consider morals clause language from an endorsement deal obtained by Sports Illustrated. The athlete in question is required to “act at all times with due regard to public morals and conventions.” In addition, he or she must refrain from conduct that “shall be an offense involving moral turpitude under federal, state or local laws, or which brings the athlete or company into public disrepute, contempt, scandal or ridicule, or which insults or offends the community.” Failure to adhere to this standard empowers the company to terminate or suspend the endorsement deal without financial cost to the company.

Notice the very low bar for wrongdoing and proof. The athlete doesn’t have to be convicted of a crime or even charged with one. Likewise, he or she doesn’t need to be found civilly liable or even sued. All it takes is the athlete partaking in conduct that “insults or offends the community” (a very vague standard, especially in today’s outrage culture) or that brings the athlete or their company “into public disrepute, contempt, scandal or ridicule.”

Athletes are often guilty until proven innocent—and it can take too long to prove innocence

Major brands have cut ties with athletes long before accusations are proven.

Take free agent NFL wide receiver Antonio Brown. He has been accused of sexual assault in a civil case. Yet Brown has not been charged with a crime, let alone convicted of one. Also, the plaintiff, Britney Taylor, has not (as far as known) provided sworn testimony to corroborate her allegations. Brown is accused of other misconduct, too. Reporting by Robert Klemko for Sports Illustrated found that Brown sent hostile texts to a different woman and engaged in other inappropriate, if not much worse, deeds. Still, it’s not clear that Brown broke any laws, civil or criminal. Brown and his representatives also adamantly deny wrongdoing.

Nike, which had paid Brown for an endorsement and prominently featured his name and likeness in sneakers, isn’t waiting to see whether the justice system—or even the NFL, which plans to meet with Brown on Thursday—believes Brown or his accuser. The footwear giant severed contractual ties with Brown the day before he was released by the Patriots.

Nike also didn’t wait to see how running back Adrian Peterson’s criminal case involving injury to his five-year-old son would be resolved. Nike suspended its contract with Peterson after he was indicted in 2014. Six weeks later, Peterson reached a plea deal that paved the way for his eventual return to the NFL. Nike took the plea deal as grounds to terminate the suspended contract.

Kobe Bryant is likewise familiar with the topic of lost endorsement deals in the wake of accusations. The retired Lakers star’s deals with such major brands as McDonald’s and Nutella were either dropped or not renewed after he was charged with sexual assault in 2003. The case, however, was dropped the following year. Also, Bryant—who admitted to having sex but insisted it was consensual—and his accuser reached a settlement out-of-court to resolve civil claims.

Companies also turn to morals clauses when athletes engage in legal but nonetheless reputation-damaging acts. In 2011, Hanesbrands terminated its endorsement deal with Rashard Mendenhall. The Steelers running back tweeted highly unpopular sentiments about the death of Osama Bin Laden and the September 11 attacks, including “It's amazing how people can HATE a man they have never even heard speak. We've only heard one side...” and “I just have a hard time believing a plane could take a skyscraper down demolition style.” Mendenhall had a First Amendment right to express opinions without fear of governmental prosecution, but the First Amendment doesn’t help with endorsement deals.

Companies are obviously not obligated to wait to see how the legal process or reputational fallout of an accused athlete plays out. Companies care about their brand. Executives at publicly traded companies also have fiduciary responsibilities to shareholders. They must pursue the best interests of the company, even if resulting actions seem hasty or unfair to an athlete whom the legal system has not faulted.

Under Amour is no different. This was shown last December. A few days after TMZ published a hotel surveillance video of Browns running back Kareem Hunt pushing and kicking a 19-year-old woman who had allegedly called him the n-word, Under Armour dropped Hunt as an endorser.

The fact that Hunt was not charged with a crime, and the possibility that he might have been provoked by racist comments, were not determinative for Under Armour. Hunt inflicting physical force on a woman and his NFL team at the time (the Chiefs) concluding that he wasn’t forthcoming were more important. Intense media and fan reaction to the video likely also motivated Under Armour.

Under Armour was well within its legal rights to cut bait with Hunt. But do athletes who currently endorse Under Armour enjoy that same discretion?

The potential role of “reverse” moral clauses

Athletes aren’t the only parties to endorsement deals who can be suspected of wrongdoing. A recent historical event involving a different company linked to accounting irregularities illustrates this point.

In the early 2000s, Enron was revealed to have engaged in widespread accounting fraud. The publicly traded energy giant, which at one time was the seventh largest company in the United States, had developed a complex record-keeping scheme to overstate revenue and hide debt. The scandal led to the criminal convictions of CEO Jeffrey Skilling and chairman Kenneth Lay. After years of litigation and turmoil, Enron ceased operations in 2007.

The fallout of the Enron scandal adversely touched many lives. Thousands of company employees lost their jobs and health care. Worse yet, many employees lost their savings, as their 401(k) plans were tied to Enron stock. The stock became worthless.

Enron’s collapse also posed implications for the sports industry. In 1999 Enron agreed to pay $100 million for the naming rights to the Astros’ ballpark, which his now named as Minute Maid Park. By 2002, Astros attorneys argued before a bankruptcy court overseeing the collapse of Enron that the ballpark should be able to rescind the naming agreement. In one court filing, the Astros noted, “the Enron logo displayed on the stadium wrongly suggests to the public that the Astros are associated with the alleged bad business practices of Enron . . . the Houston Astros arguably are viewed as Enron's team.”

One legal hurdle for the Astros was the absence of a morals clause or its equivalent to exit the deal. Enron attorneys insisted that the naming agreement was an asset to the company—and to its creditors—and one that could not be unilaterally rescinded. The Astros eventually had to pay Enron more than $2 million to buy the name of its own ballpark from Enron.

One seldom used, but nonetheless useful approach to endorsement deals is to provide both parties an opportunity to exit the agreement if the other is implicated in controversy. The ability of a performer to end an endorsement deal is sometimes called a “reverse morals clause.”

The first known reverse morals clause was in the music industry, and specifically with singer Pat Boone. Boone extended his contract with DOT Records upon the condition that he could exit if the company published music featuring themes and album covers that he deemed incompatible with his faith. Boone was said to be troubled by late 1960s cultural shifts. Those shifts impacted music industry, and Boone objected to the album cover for John Lennon and Yoko Ono’s Unfinished Music No.1: Two Virgins. The couple were photographed nude on that cover. Boone didn’t want to work with a record label that embraced that type of imagery.

Yet reverse morals clauses remain rare, and athletes and their agents do not seem to prioritize them in negotiations. Perhaps it’s because an athlete is confident that he or she can distinguish their reputations from an endorsed company that comes under fire. Or maybe it’s because other aspects of an endorsement deal—particularly the negotiated compensation and proposed product line—dominate the athlete’s attention.

But especially in the world of sportswear and sneakers, athlete endorsers need not look hard to find risk to their own brands. While Under Armour is dealing with a high-profile accounting dilemma, Adidas employees and consultants were recently convicted in the college basketball corruption fraud prosecutions. Nike hasn’t escaped that scandal, either. Companies also risk public and backlash in pursuing business dealings that raise sensitive political issues, such as the NBA and sneaker companies’ pursuits in China.

In an era where anger on social media can quickly alter the trajectory of any given controversy, athletes might want protection to drop ties with brands that wouldn’t hesitate to drop them if the roles were reversed.

Michael McCann is SI’s Legal Analyst. He is also an attorney and the Director of the Sports and Entertainment Law Institute at the University of New Hampshire Franklin Pierce School of Law.