SECURITIES ACT OF 1933
Release No. 7917 / November 16, 2000
SECURITIES EXCHANGE ACT OF 1934
Release No. 43572 / November 16, 2000
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 1345 / November 16, 2000
ADMINISTRATIVE PROCEEDING
File No. 3-10366
| In the Matter of JAMES STEELE DOUGLASS |
ORDER INSTITUTING PUBLIC PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS AND IMPOSING CEASE-AND-DESIST ORDER |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against James Steele Douglass ("Douglass").
In anticipation of the institution of these proceedings, Douglass has submitted an Offer of Settlement, which Offer the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, Douglass, by his Offer of Settlement, admits the jurisdiction of the Commission over him and the subject matter of these administrative proceedings and consents to the entry of this Order Instituting Public Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing Cease-and-Desist Order ("Order"), without admitting or denying the Commission's findings, except as for those contained in paragraph III.A, which are admitted.
II.
Accordingly, IT IS HEREBY ORDERED THAT proceedings pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act be, and hereby are, instituted.
III.
On the basis of this Order and the Offer of Settlement by Douglass, the Commission makes the following findings1:
FACTS
A. Douglass joined an Atlanta-based supplier of business management services to physicians and hospitals (the "Company") in July 1994 as the Company's controller. He later became a vice president and the chief accounting officer, reporting to the Company's chief financial officer. Douglass continued to hold these positions until he voluntarily left the Company in September 1996. The Company's securities were registered with the Commission pursuant to Section 12(g) of the Exchange Act.
B. In the first quarter of 1996, Douglass was involved in the reversal of an accrual for vested employee bonuses of $1.4 million into income by a wholly-owned subsidiary of the Company. The effect of this reversal was to decrease expenses and liabilities by this amount and increase income for the first quarter of 1996 on the Company's consolidated financial statements.
C. The employee bonus plan at this subsidiary was a deferred compensation arrangement with vested benefits. While the plan contained language allowing management certain discretion to cancel all bonuses, no changes were in fact made to the operation of the plan. The employees covered by this plan had already earned these bonuses from past services and their right to payment required no additional services. Accrual for this liability was appropriate and its reversal into income was a departure from generally accepted accounting principles ("GAAP"). The Company determined to reinstate the accrual in the third quarter of 1996.
D. In the second quarter of 1996, the Company acquired an information technology provider and consulting firm based in Texas (the "Texas firm"). Before the completion of the acquisition, the Company directed the Texas firm to make entries that improperly reduced its income for the first quarter of 1996 by decreasing revenues and increasing reserves. Douglass was aware of the establishment of these reserves. In June 1996, Douglass instructed the Texas firm, now a wholly-owned subsidiary, to reverse this $2.5 million in reserves into income.
E. Since there were no probable and reasonably estimable exposures to justify the establishment of these reserves, these reserves were not booked or reversed in conformity with GAAP. The reversal of these reserves into income materially inflated the Company's earnings through consolidation in the second quarter of 1996.
F. In the second quarter of 1996, Douglass learned that a Company subsidiary expected to incur additional costs to complete certain software development and consulting contracts. The Company had already recognized as revenue all payments provided under these contracts, but Douglass learned that the subsidiary, and the Company through consolidation, would be exposed to additional material costs on these arrangements.
G. Despite being aware by the end of the second quarter that additional costs would be incurred, Douglass failed to cause the Company to record the exposures on the Company's books and failed to establish any reserves for them. As a result, the Company departed from GAAP and overstated the earnings from these contracts, and its revenue, during the second quarter. In 1997, the Company recorded approximately $1.4 million of additional costs on these contracts as of the second quarter of 1996.
H. During the first and second quarters of 1996, the Company failed to have internal controls sufficient to ensure that its financial statements were prepared in conformity with GAAP. The Company had no formal written corporate-wide accounting policies and procedures to ensure the application of consistent accounting practices throughout the Company. Control weaknesses resulted in incorrect books and records and misleading financial statements reported by the Company in filings with the Commission. The Company had no review process to ensure that reversals of accruals into income were proper and had appropriate supporting documentation. The Company improperly established reserves at a subsidiary without probable and reasonably estimable exposures, later reversing them into income. The Company failed to have adequate procedures to ensure the recording of reserves for probable losses on its software development contracts, even though it was aware that such losses were probable and should have been recorded.
I. Douglass, as the Company's controller and chief accounting officer, failed to implement a system of sufficient internal controls to ensure that the Company's financial statements were prepared in accordance with GAAP.
J. Douglass also failed to assure compliance with those internal controls the Company did have with respect to the accounting entries described above.
K. On May 15, 1996, the Company filed its Form 10-Q for the first quarter of 1996, reporting net income for the quarter of $13.2 million, a figure which was misstated due to the inclusion of the bonus accrual which a Company subsidiary had improperly reversed into income. Douglass signed this Form 10-Q as "Vice President - Corporate Controller and Chief Accounting Officer (Principal Accounting Officer)."
L. The Company filed its Form 10-Q for the second quarter of 1996 on August 14, 1996. The net income figure of $3.3 million reported for this quarter was overstated due to the improper establishment and reversal of reserves at a company the Company acquired during the second quarter and the failure to accrue for probable losses on certain software development contracts at a subsidiary. Additionally, the Company overstated its results for the first six months of 1996 in this Form 10-Q because the improper reversal of the bonus accrual in the first quarter of 1996 was included in its year-to-date results. Douglass signed this Form 10-Q as "Vice President - Corporate Controller and Chief Accounting Officer (Principal Accounting Officer)."
M. On June 28, 1996, the Company filed a registration statement on Form S-8 with the Commission. This registration statement incorporated by reference the Company's inaccurate Form 10-Q for the first quarter of 1996, as discussed in paragraphs III.B and III.C of the Order. Douglass signed this registration statement as "Vice President, Corporate Controller and Chief Accounting Officer."
N. In early 1997, the Company restated the operating results it had previously reported for each quarter of 1996. The restatements of the first and second quarters of 1996 were to correct, among other items, the improper reversal into income of the employee bonus plan accrual, the improper reversal of reserves at the Texas firm and its failure to establish reserves for the probable losses on a subsidiary's software development contracts. The restatement materially reduced the Company's net income for the first and second quarters and changed the net income reported for the second quarter of 1996 into a net loss.
VIOLATIONS OF THE FEDERAL SECURITIES LAWS
B. Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, collectively, make it unlawful to employ, directly or indirectly, devices, schemes or artifices to defraud, to make any untrue statement of material fact or omit to state material facts necessary in order to make statements made not misleading in connection with the offer, purchase or sale of securities. Furthermore, these antifraud provisions make it unlawful to engage in any act, practice or course of business which operates or would operate as a fraud in connection with the offer, purchase or sale of securities.
B. Section 13(a) of the Exchange Act and Rule 13a-13 thereunder require issuers of registered securities to file with the Commission quarterly reports prepared in conformity with the requirements of the Commission's rules and regulations. Courts have held that it is implicit in this requirement that the information provided be accurate and contain no material misrepresentations or omissions. See, e.g., SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). In addition, Exchange Act Rule 12b-20 requires that these periodic reports contain all information necessary to ensure that the statements made in them are not materially misleading. No showing of scienter is necessary to establish a violation of Section 13(a). Savoy Industries, 587 F.2d at 1167. A violation occurs when a materially false statement is filed. SEC v. Kalvex, Inc., 425 F.Supp. 310, 316 (S.D.N.Y. 1975).
C. Section 13(b)(2)(A) of the Exchange Act requires issuers of securities to make and keep books, records and accounts which accurately and fairly reflect their transactions and the dispositions of their assets. Exchange Act Rule 13b2-1 prohibits any person from, directly or indirectly, falsifying or causing to be falsified any book, record or account subject to Section 13(b)(2)(A). Exchange Act Rule 13b2-2 provides that no director or officer of an issuer shall make any false or materially misleading statement, or omit to state or cause another to omit to state any material fact necessary to make statements made not misleading to an accountant in connection with, inter alia, the preparation or filing of any document or report required to be filed with the Commission.
D. Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are executed in accordance with management's authorization and that transactions are recorded as necessary to permit the preparation of financial statements in conformity with GAAP and to maintain accountability for assets.
E. Section 13(b)(5) of the Exchange Act prohibits persons from knowingly circumventing or knowingly failing to implement a system of internal accounting controls or knowingly falsifying any book, record or account described in Section 13(b)(2) of the Exchange Act.
F. By engaging in the conduct described above, Douglass violated Section 17(a) of the Securities Act and Section 10(b) the Exchange Act and Rule 10b-5 thereunder. These acts resulted in the Company filing materially misleading financial statements in its Forms 10-Q for the first and second quarters of 1996 and, through incorporation, in a registration statement on Form S-8 filed in June 1996.
G. Douglass violated Rule 13b2-1 by causing the Company's books and records to falsely overstate the Company's income for the first and second quarters of 1996. Douglass also violated Rule 13b2-2 by omitting to give accurate and complete information to the Company's outside auditors concerning the nature of the entries on the Company's books and records during the first and second quarters of 1996.
H. Douglass violated Section 13(b)(5) of the Exchange Act by failing to implement a system of internal accounting controls sufficient to prevent the Company's departures from GAAP.
I. Additionally, Douglass caused the Company to violate Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder by causing the Company to file inaccurate Forms 10-Q for the first and second quarters of 1996. Douglass caused the Company to violate Section 13(b)(2)(A) of the Exchange Act by causing the Company's books and records to inaccurately record its transactions. Douglass also caused the Company to violate Section 13(b)(2)(B) of the Exchange Act by failing to ensure that the Company had sufficient internal accounting controls to provide reasonable assurances that its financial statements were prepared in accordance with GAAP.
J. By the acts and omissions alleged in paragraphs III.B through III.M of the Order, Douglass committed violations of Section 17(a) of the Securities Act and Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder and caused the Company to violate Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
IV.
In view of the foregoing, the Commission deems it appropriate to accept Douglass's Offer of Settlement.
ACCORDINGLY, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act that Douglass cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-13, 13b2-1 and 13b2-2 thereunder.
By the Commission.
Jonathan G. Katz
Secretary
Footnote
| 1 | The findings herein are made pursuant to Douglass's Offer of Settlement and are not binding on any other person or entity named in this or any other proceeding. |