UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7327 / September 5, 1996 SECURITIES EXCHANGE ACT OF 1934 Release No. 37649 / September 5, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 812 / September 5, 1996 ADMINISTRATIVE PROCEEDING File No. 3-9070 ----------------------------------- : ORDER INSTITUTING In the Matter of : PROCEEDINGS PURSUANT TO : SECTION 8A OF THE SECURITIES ADVANCED MEDICAL PRODUCTS, INC., : ACT OF 1933 AND SECTION 21C CLARENCE P. GROFF, and : OF THE SECURITIES EXCHANGE JAMES H. BROWN, : ACT OF 1934, MAKING FINDINGS : AND IMPOSING A CEASE-AND- Respondents. : DESIST ORDER : ------------------------------------ I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that cease-and-desist proceedings be instituted against Advanced Medical Products, Inc. ("AMP"), Clarence P. Groff ("Groff") and James H. Brown ("Brown")(collectively "Respondents"), pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"). II. In anticipation of the institution of these cease-and-desist proceedings, the Respondents have submitted Offers of Settlement ("Offers"), which the Commission has determined to accept. Solely for the purpose of these proceedings, and any other proceedings brought by or on behalf of the Commission, or in which the Commission is a party, without admitting or denying the findings set forth below, except as to jurisdiction, which AMP, Groff and Brown admit, AMP, Groff and Brown consent to the entry of the findings and Cease-and-Desist Order set forth below. III. ==========================================START OF PAGE 2====== Accordingly, IT IS ORDERED that cease-and-desist proceedings, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, be, and hereby are, instituted against AMP, Groff and Brown. IV. On the basis of this Order and the Respondents' Offers of Settlement, the Commission finds: -[1]- A. FACTS 1. Respondents. a. AMP, which was incorporated in Delaware on September 3, 1986, develops, manufactures and markets medical diagnostic equipment. During the time of the events discussed herein, AMP's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act and quoted on the NASDAQ system under the symbol "ADVA". In 1993, AMP moved its operations from Syracuse, New York, to Columbia, South Carolina. b. During the periods discussed herein, Groff was the President, Chief Executive Officer, Treasurer, Chief Financial Officer and Chairman of the Board of AMP and, with his family, owned approximately 23% of AMP's common stock. Groff, who is not a certified public accountant, was an officer and director of AMP from 1986 through 1996. c. Brown is Vice President, Secretary and a Director of AMP and, with his family, owns approximately 6% of AMP's common stock. From in or about early 1988 to in or about the fall of 1992, Brown supervised AMP's sales and marketing operations. Since the fall of 1992, Brown has been responsible for an AMP business unit and for the international sales related to that unit. Brown has been an officer and director of AMP since its inception. ---------FOOTNOTES---------- -[1]- The findings herein are made pursuant to the Respondents' Offers of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding. ==========================================START OF PAGE 3====== 2. Accounting Principles Applicable to the Recognition of Revenue. Generally Accepted Accounting Principles ("GAAP") provide that revenue should not be recognized until an exchange has occurred, the earnings process is complete, and the collection of the sales price is reasonably assured. These conditions ordinarily are met when products are exchanged for cash or claims to cash, and when the entity has substantially performed the obligations which entitle it to the benefits represented by the revenue. Generally, a transfer of risk has to occur in order to effect an "exchange" for the purposes of revenue recognition. 3. AMP's Improper Revenue Recognition Practices. This proceeding involves improper conduct by AMP which included the making of material misrepresentations regarding AMP's net sales and income before taxes as reported in certain of AMP's annual and quarterly reports filed with the Commission. Specifically, AMP, under the direction of Groff and Brown, engaged in improper revenue recognition practices causing it to overstate its net sales by at least 18.65%, 29.89%, 5.0% and 30.86% as reported in its Forms 10-Q for the periods ended September 30, 1991, December 31, 1991, September 30, 1992 and December 31, 1992, respectively. Additionally, AMP's improper revenue recognition practices caused it to overstate income before taxes by approximately $113,000 as reported in its Form 10-K for the period ended June 30, 1992, and by approximately $130,000, $249,000 and $172,000 as reported in its Forms 10-Q for the periods ended September 30, 1991, December 31, 1991 and December 31, 1992, respectively. AMP engaged in at least five different practices which caused it to improperly recognize revenue, as detailed below. a. AMP's Improper Recognition of Revenue Upon Shipment to its Field Representatives. AMP prematurely recognized revenue from transactions where the product that AMP recorded as being "sold" had not yet been shipped to the customer. AMP's sales to its domestic customers were usually shipped to its field representatives, who were responsible for product installation and training the purchaser in the use of AMP's products. AMP's policy was to recognize revenue upon shipment of equipment from its plant to its field representatives. However, AMP's policy did not comply with GAAP because an exchange did not occur until AMP's products were shipped to the customer, rather than to the field representatives. Additionally, risk of loss did not pass when the equipment was shipped to the field representative, rather than to the customer, because the equipment was still in AMP's control. Nevertheless, AMP recognized revenue on such sales. Finally, AMP's practice of recognizing revenue at the time of ==========================================START OF PAGE 4====== shipment from its plant was improper because, at that time, the collection of the sales price was not reasonably assured. Specifically, the customer had no obligation to pay for the equipment until it was delivered to the customer and installed. Groff and Brown directed AMP's practice of improperly recognizing revenue upon shipment to the field representative. b. "Soft Sales" AMP, at the direction of Groff and Brown, improperly recorded in its books and records shipments of "soft sales," or sales for which customers had expressed some interest, but had not yet committed to purchase AMP's product. In this manner, Groff and Brown circumvented AMP's internal control procedures in order to prematurely recognize revenue. Specifically, Groff and Brown conducted meetings at the end of each month for the purpose of approving these "soft sales," which did not contain the documentation evidencing a bona fide sale as required by AMP's internal control procedures. In cases of "soft sales" which were actually shipped to AMP's field representatives, the field representatives usually retained the equipment until the customer decided to purchase the equipment (which, in many instances, occurred months later) or until the field representatives attempted to return the equipment to AMP at some later date. Further, in certain instances, AMP did not ship the equipment related to the "soft sales" to its field representatives, but, instead, shipped the equipment to AMP's corporate offices. To prevent customer complaints resulting from being invoiced for equipment which they had not committed to purchase, AMP's employees often culled outgoing invoices and monthly statements pertaining to "soft sales" to preclude their distribution to unsuspecting customers. Finally, for the quarter ended December 31, 1992, Brown told AMP's Controller to post a "sales accrual" in the amount of $173,000 for international sales. However, none of these "sales" had been shipped as of December 31, 1992. In fact, $21,000 of the $173,000 of "sales" were never shipped at all and were subsequently written off AMP's books and records. c. AMP Improperly Held Open its Accounting Periods. AMP improperly held open accounting periods to record additional end-of-period sales. Specifically, AMP often did not close its books at the end of each interim and annual period, as it reported that it did in its financial statements filed with the Commission. Rather, AMP typically held open its books for between one to eight days subsequent to the end of each reporting quarter or annual period. As a result, sales which were shipped and invoiced after the end of a reporting quarter or fiscal year were included as part of the previous quarter's or year's sales. Significantly, a material percentage of AMP's sales occurred in ==========================================START OF PAGE 5====== those days following its proper quarter-ends. For example, for the quarter ended December 31, 1992, approximately 40% of AMP's reported net sales related to shipments that occurred after December 31, 1992. d. Improper "Sale" to an International Customer. AMP prematurely recognized a significant amount of revenue on a sale to an international customer. Specifically, during the fourth quarter of fiscal 1992, AMP recorded a sale to a large international customer ("international customer") in the amount of $136,850. However, the equipment shipped was an old model, not the "New Age" model called for by the international customer's purchase order (AMP's "New Age" model was not yet available for sale). Additionally, the shipment was made to a Syracuse warehouse, rather than to the international customer's usual freight forwarder located at Kennedy Airport. In fact, pursuant to Brown's instructions, the equipment was being stored for AMP with no further shipping instructions. AMP ultimately reversed the transaction for fiscal 1992, but subsequently included the transaction as a sale for the quarter ended September 30, 1992, AMP's first quarter of fiscal 1993. Thereafter, on January 5, 1993, AMP shipped the "New Age" equipment which conformed to the international customer's initial purchase order. e. AMP Improperly Recognized Revenue on Backordered Equipment. AMP improperly recognized revenue on backordered equipment. Due to Groff's and Brown's approval of a disproportionate number of "soft sales" during the last two weeks of each quarter, AMP frequently experienced a shortage of finished goods inventory to fill bona fide orders. Upon experiencing shortages of finished goods, AMP classified such shortages as backordered equipment. As a result, AMP often made partial shipments of orders in an accounting period and shipped the balance of the order in a subsequent accounting period. Nevertheless, AMP recognized the revenue on the complete order in the earlier accounting period. Specifically, with respect to international sales, until the end of fiscal 1993, AMP's policy was to recognize revenue on 100% of an order when only 50% or more of the order had been shipped. AMP's Controller typically made a journal entry at the end of each period to recognize the revenue on the aggregate of all international sales. With respect to domestic sales, AMP also recognized revenue on an entire order as long as AMP shipped the minimum equipment necessary to constitute an "operational" system. As a result, AMP improperly recognized revenue on equipment which had not been shipped. Groff and Brown were aware of, and sanctioned, this policy. ==========================================START OF PAGE 6====== 4. AMP's Books and Records Deficiencies Resulting from the Improper Accounting for its Accounts Receivable Write Offs. In those instances in which AMP eventually wrote off as sales returns accounts receivable which were associated with "soft sales," AMP improperly accounted for the write offs such that AMP overstated its revenue, cost of sales and commission expenses as reported in certain of its financial statements which were filed with the Commission. Beginning in the fall of 1990, AMP established a sales returns and allowance ("SR&A") account. AMP's SR&A account served to reduce its then current period's gross sales by an estimate of future sales returns attributable to such current sales. Through this process, revenues and related estimated expenses were matched in an attempt to more fairly reflect periodic net income. Although an SR&A account generally represents an estimate of probable future sales returns, for reasons such as customer dissatisfaction with the product, which relate to current period sales, few of AMP's sales returns resulted from reasons such as customer dissatisfaction. Rather, AMP's sales returns resulted primarily from AMP's improper revenue recognition policy and Groff's practice of approving "soft sales." Although AMP's SR&A account was established to more accurately reflect AMP's sales for a particular period, AMP's accounting for the SR&A account was improper for two reasons. First, AMP's estimates of sales returns during the relevant periods were consistently less than its actual sales returns experience. -[2]- Consequently, because the amount of AMP's actual sales returns exceeded the amount which AMP reflected in its financial statements, AMP overstated net sales during the period. In addition, AMP's actual sales returns experience was artificially low because, among other reasons, Groff and Brown delayed AMP's recognition of sales returns. Specifically, AMP refused to accept sales returns from its field representatives until such time as management felt that, in light of AMP's sales for the particular quarter, AMP could afford to write the sales off its books and records. Second, in those instances when AMP did accept sales returns, AMP incorrectly recorded journal entries to account for such sales returns. Specifically, when AMP accounted for a sales ---------FOOTNOTES---------- -[2]- The term "returns" is actually a misnomer in this context in that, almost always, the equipment was never actually delivered to the customer, but, rather, remained in AMP's control, either in the possession of the field representatives or in AMP's offices. ==========================================START OF PAGE 7====== return, it recorded a journal entry to write off the receivables associated with the sales returned by an amount equal to the gross sales price less the cost of inventory and commission expense associated with the sale. Such methodology caused AMP to overstate its net sales, cost of goods sold, gross profit and general, administrative and sales expenses as reported in AMP's Forms 10-Q for the quarters ended September 30, 1991, December 31, 1991, December 31, 1992 and March 31, 1993, and in AMP's Form 10-K for the year ended June 30, 1992. B. LEGAL DISCUSSION Section 17(a) of the Securities Act prohibits fraud "in the offer or sale" and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraud "in connection with the purchase or sale" of securities. SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1171 (D.C. Cir.), cert. denied, 440 U.S. 913 (1978). The fraudulent practices prohibited by both statutes include the use of devices, schemes or artifices to defraud and the making of material misrepresentations of fact and omissions of material facts. Groff, as Chief Financial Officer of AMP, was primarily responsible for the accuracy and propriety of AMP's financial statements. Groff also reviewed and signed all of AMP's quarterly filings on Form 10-Q and annual filings on Form 10-K. However, Groff was aware of the fact that AMP recognized revenue when AMP shipped its product to its field representatives, rather than when the customer received the equipment. Groff also participated in the month-end meetings at which most of AMP's "soft sales" were approved. Further, Groff was aware of the "sale" to the large international customer. Finally, Groff was aware of AMP's policy of recognizing 100% of the revenue on an order when only 50% or more of the order had been shipped. Between 1988 and 1992, Brown was AMP's Vice President in charge of domestic and international sales. Brown also signed AMP's annual reports on Form 10-K, including AMP's 1992 Form 10- K. However, Brown was aware of AMP's policy of recognizing revenue upon shipment to AMP's field representatives. Brown also attended AMP's month-end sales meetings at which he typically argued that AMP should recognize revenue on any "soft sales." Further, Brown was responsible for AMP improperly booking revenue on the "sale" to the large international customer. Finally, Brown was aware of AMP's practice of recognizing 100% of revenue on an order when only 50% or more of the equipment had been shipped. Thus, AMP, based upon the conduct set forth supra, and Groff and Brown, by directing the improper accounting practices, violated the antifraud provisions of the Securities Act and the Exchange Act in connection with AMP's materially false filings with the Commission. ==========================================START OF PAGE 8====== Section 13(b)(2)(A) of the Exchange Act requires that every reporting company keep books and records which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of such company. Rule 13b2-1 provides that no person shall falsify or cause to be falsified any book, record or account subject to Section 13(b)(2)(A). A showing of scienter is not required to establish a violation of Section 13(b)(2). SEC v. World-Wide Coin Investments, 567 F. Supp. 724, 749 (N.D. Ga. 1982). Rule 13b2-2 prohibits an officer or director from directly or indirectly making or causing to be made materially false or misleading statements or omissions to an accountant in connection with an audit or the preparation or filing of any report required to be filed with the Commission. By engaging in the conduct described above, Groff caused AMP's books and records to be false. In addition, Groff signed a letter each year to AMP's auditors making certain representations regarding the accuracy of AMP's financial statements and books and records. Among the representations made by Groff which were contained in the letter concerning the auditor's fiscal 1992 audit was Groff's statement that "[t]here are no material transactions that have not been properly recorded in the accounting records underlying the financial statements." As described above, this statement was false. Additionally, Brown directed AMP's Controllers to record in AMP's books and records "soft sales" and sales which had not yet been shipped to a customer. Through the above conduct, AMP violated, and Groff and Brown caused AMP to violate, the issuer books and records provisions of the Exchange Act. Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 promulgated thereunder require that an issuer of a security registered pursuant to Section 12 of the Exchange Act file annual and quarterly reports with the Commission. Rule 12b-20 requires that the annual and quarterly reports include any material information as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. Implicit in the obligation to file reports under Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 is the requirement that the information contained therein be true and correct. SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975); see also Savoy Industries, 587 F.2d at 1165. Regulation S-X requires that financial statements filed with the Commission be presented in conformity with GAAP, unless the Commission otherwise provides. Failure to present financial statements in conformity with GAAP results in a presumption that the statements are misleading and inaccurate. 17 C.F.R.  210.4- 01(a)(1). A showing of scienter is not required to establish a violation of the reporting requirements of Section 13(a). SEC v. Wills, 472 F. Supp. 1250, 1268 (D.D.C. 1978). As set forth herein, AMP's Form 10-K for the period ended June 30, 1992 and AMP's Forms 10-Q for the periods ended September 30, 1991, ==========================================START OF PAGE 9====== December 31, 1991, September 30, 1992, December 31, 1992 and March 31, 1993 failed to comply with GAAP. Accordingly, AMP violated, and Groff and Brown, by directing the improper accounting conduct described above, caused AMP's violations of, the periodic reporting provisions of the Exchange Act. V. In view of the foregoing, the Commission finds that: A. AMP violated Section 17(a) of the Securities Act and Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 thereunder; B. Groff violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and caused AMP to violate Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a- 13 thereunder; and C. Brown violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and caused AMP to violate Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a- 13 thereunder. VI. Based on the foregoing, the Commission deems it appropriate and in the public interest to impose the cease-and-desist orders as specified in the Respondents' Offers of Settlement. ACCORDINGLY, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that: A. AMP cease-and-desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 thereunder; B. Groff cease-and-desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Section 10(b) the Exchange Act and Rules 10b- 5, 13b2-1 and 13b2-2 thereunder, and causing any violations and any future violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder; and C. Brown cease-and-desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Section 10(b) the Exchange Act and Rules 10b- 5, 13b2-1 and 13b2-2 thereunder, and causing any violations and ==========================================START OF PAGE 10====== any future violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary