UNITED STATES OF AMERICA SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7518 / March 25, 1998 SECURITIES EXCHANGE ACT OF 1934 Release No. 39791 / March 25, 1998 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 1017 / March 25, 1998 ADMINISTRATIVE PROCEEDING File No. 3-9563 : ORDER INSTITUTING PUBLIC In the Matter of : ADMINISTRATIVE PROCEEDINGS, : MAKING FINDINGS, AND ISSUING SENSORMATIC ELECTRONICS : CEASE-AND-DESIST ORDER CORPORATION, : : Respondent. : : I. The Commission deems it appropriate that public administrative proceedings be, and they hereby are, instituted against Sensormatic Electronics Corporation ("Sensormatic") 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 administrative proceedings, Sensormatic has submitted an Offer of Settlement ("Offer"), which 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 to which the Commission is a party, Sensormatic, without admitting or denying the findings contained in this order, consents to the issuance of this Order Instituting Public Administrative Proceedings, Making Findings, and Issuing Cease-and-Desist Order ("Order"), the findings contained herein, and the imposition of the relief set forth below. III. The Commission makes the following findings:[1] A.FACTS 1.Summary From at least the start of its fiscal year 1994 (July 1, 1993) through July 10, 1995, Sensormatic manipulated its quarterly revenue and earnings in order to reach its budgeted earnings goals and thereby meet analysts' quarterly earnings projections. Sensormatic carried out this fraudulent scheme by improperly recognizing revenue through several different practices. The conduct, which occurred over a number of years and involved employees throughout the organization, primarily involved recognizing and recording revenue in one quarter from product shipped in the next quarter. At the end of each quarter Sensormatic turned back its computer clock that recorded and dated shipments so that out-of-period shipments, and consequently revenue, would be recorded in the prior quarter. As a result of its improper revenue recognition practices, Sensormatic misstated its quarterly earnings in financial statements contained in periodic reports and registration statements filed with the Commission during the period between the start of its 1994 fiscal year through the third quarter of fiscal year 1995. In addition, Sensormatic issued a press release that overstated its preliminary estimates of earnings for the fourth quarter of fiscal year 1995 by over 40% and for the year by over 18%. Sensormatic's misstatements of its quarterly net income ranged from an understatement of about $1.9 million (an understatement of 9.1%) in the second quarter of fiscal year 1994 to an overstatement of about $5.2 million (an overstatement of 40.5%) in the fourth quarter of fiscal year 1995. During the relevant period, Sensormatic's senior management, including Sensormatic's former Chief Financial Officer ("CFO"), who also was the Chief Operating Officer ("COO") and Executive Vice President, and its former Vice President of Finance ("VP of Finance"), not only was aware of the methods used to effectuate the scheme, but also condoned and directed them. Others at various levels and in various departments also participated in these practices. **FOOTNOTES** [1]:The Commission's findings herein are made pursuant to Sensormatic's Offer and are not binding upon any other person or entity in these or any other proceedings. 2.Respondent:Sensormatic Electronics Corporation Sensormatic is a Delaware corporation with its principal executive offices in Boca Raton, Florida. The company manufactures and markets electronic security systems used, among other things, to deter shoplifting. Sensormatic's stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and is traded on the New York Stock Exchange. As of September 19, 1997, Sensormatic had 74,288,369 shares of common stock outstanding. For fiscal years 1994 and 1995, Sensormatic reported revenues of approximately $656 million and $889.1 million, respectively. Sensormatic's earnings were determined primarily by the recognition of revenue from the sale of equipment. 3.Manipulation of Quarterly Earnings (a)Background The investment community viewed Sensormatic as a growth company, a view that the company fostered through, among other things, press releases announcing its significant growth. For fiscal years 1988 through 1995, Sensormatic internally budgeted and achieved revenue growth of over 20% per year. Up until its July 7, 1995 announcement that its earnings for the fourth quarter of fiscal year 1995 would be "substantially below" expectations, the company had reported earnings consistent with analysts' quarterly earnings projections for ten consecutive years. During the relevant period, Sensormatic stated in reports filed with the Commission and disseminated to the public that it recognized revenue upon shipment of product. In preparation for the end of each quarter, a Sensormatic employee prepared weekly "To-Go" memoranda containing the sales goals that needed to be achieved to reach the company's budgeted earnings goals and estimating the amounts of sales that still needed to be made to achieve the budget. The memoranda were addressed and circulated to top management, including the CFO and the VP of Finance, and were also copied and sent to others in various departments. At the start of the last month of each quarter, the company usually was short of its sales goals. In the last days of each quarter, the sales department undertook dramatic efforts, including, among other things, reducing prices and offering favorable payment terms, to close sufficient sales to make the goals. Through memoranda and responses to its inquiries, senior management, including the Chief Executive Officer, was kept regularly informed about the status of the quarter. When senior Sensormatic management determined that the company could not attain its budgeted goals, Sensormatic engaged in a variety of improper revenue recognition practices described below that were not in conformity with Generally Accepted Accounting Principles ("GAAP"), including the following: out-of-period shipments, whereby the company recognized revenue in one quarter on goods that were actually shipped in the next quarter; recognizing revenue when customer shipments were made to a warehouse leased by Sensormatic rather than directly to the customer; slow shipping, whereby the company recognized revenue when it shipped goods at the end of the quarter but requested the carrier to delay delivery beyond normal transit times to meet a customer's requested delivery date in the new quarter; and recognizing revenue on FOB destination sales when the product was shipped from Sensormatic rather than at the time when the shipment arrived at the indicated destination, when title and risk of loss passed to the customer. During the period from fiscal year 1994 through fiscal year 1995,[2] the amount of out-of-period revenue that Sensormatic recognized in quarters ranged from $4.6 million to $30.2 million. (b)Out-of-Period Shipments During the relevant period, Sensormatic recognized revenue on out-of-period shipments in every reporting period. Sensormatic carried out this practice as described below. On or shortly before the last day of a quarter, employees from the sales, manufacturing, and shipping departments of Sensormatic met to determine what purchase orders were expected to be received and processed and how long it would take to ship the related product. During the relevant period, purchase orders were accepted through the last day of the quarter and processed late into the night on that day. On at least one occasion, orders were accepted throughout the first day of the next quarter but were recorded as having been received in the previous quarter. If these last minute orders could not be shipped by midnight on the last day of the quarter, the decision was made, usually by Sensormatic's VP of Finance or its CFO, as to how much product to ship after the end of the quarter. Sensormatic then shipped goods for a number of days past the end of the quarter by going through a complicated and costly process to backdate computer-generated records of these shipments. Shortly before midnight on the last day of the quarter, the computer system that recorded and dated shipments was "brought down" so that the computer clock date would reflect the last day of the prior quarter. The computer system then falsely recorded shipments as having occurred on the last day of the prior quarter. (c)Warehouse Shipments During part of the relevant period, Sensormatic improperly recognized revenue on products it shipped to warehouses leased by it. The product had been ordered by customers but it was not scheduled to be delivered to the customer until sometime during the next quarter. Nevertheless, Sensormatic recognized revenue in such situations when the product was first shipped to the warehouse. To ensure that orders eventually were sent to customers at the appropriate time, Sensormatic created a set of "off-books" records to track the warehouse shipments on which revenue was prematurely recognized. Certain Sensormatic employees destroyed their copies of off-books records during the fiscal year 1995 audit. For example, in December 1994, Sensormatic shipped $8 million of goods ordered by one of its largest customers to a warehouse that Sensormatic leased. These goods were shipped to the customer over the next several months, yet Sensormatic prematurely recognized the entire $8 million as revenue in the second quarter of fiscal year 1995, ended December 31, 1994, upon the shipment to the warehouse. (d)Slow Shipments During the relevant period, Sensormatic improperly recognized revenue on shipments made during the last days of the quarter but not scheduled to arrive at the customers' location until well into the next quarter. Sensormatic recorded revenue in the quarter just ending, although it had requested carriers to delay delivery of the goods by a few days to as much as a few weeks beyond normal transit times. (e)FOB Destination Shipments Sensormatic also improperly recognized revenue when goods were shipped to customers whose contracts and/or purchase orders included FOB destination terms. Under GAAP, revenue should not be recognized in these situations until goods reach their destination, at which point title and risk of loss pass to the customer. During the relevant period, for at least some of its FOB destination customers, Sensormatic improperly recognized revenue during the last week of certain quarters when shipments left the Sensormatic location. This revenue was prematurely recognized because these shipments did not reach the customer's indicated destination before the end of the quarters. For example, at the end of the third quarter of fiscal year 1995, Sensormatic prematurely recognized a substantial amount of revenue when goods were shipped to a customer whose contract with Sensormatic contained an FOB destination provision. (f)The Purpose of the Improper Revenue Recognition Sensormatic knew and understood that its stock, which traded at a high price/earnings ratio, was sensitive to quarterly earnings announcements. The company also was concerned with its stock price because it issued stock to finance its acquisitions. Sensormatic senior management regularly communicated with the analyst community, providing information about its earnings goals which the analysts used in determining their quarterly earnings projections for the company. As each quarter progressed, Sensormatic senior management knew the earnings projections being made by the analysts and understood that the company would meet the analysts' quarterly earnings projections if it met its budgeted earnings goals. Thus, Sensormatic manipulated its earnings to meet its goals and thereby meet analysts' projections. Sensormatic's revenue recognition practices also smoothed the company's reported earnings over the course of a year and, in particular, obscured Sensormatic's seasonally weaker third quarter. During the relevant period, Sensormatic consistently met, within one cent, the analysts' forecasts of quarterly earnings per share ("EPS"), even for the third quarters, the quarter in which Sensormatic had the largest gap between its actual EPS and the analysts' quarterly EPS forecasts. For the third quarter of fiscal year 1994, the analysts' final EPS projection was $0.27, Sensormatic reported $0.26 EPS, and the actual EPS was $0.21. For the third quarter of fiscal year 1995, the analysts' EPS projection was $0.33, Sensormatic reported $0.33 EPS, and the restated EPS was $0.21. (g)Sensormatic's Filings and Press Release As a result of its improper revenue recognition practices, Sensormatic inaccurately reported quarterly revenue and thereby misstated its quarterly net income and EPS. The chart below summarizes Sensormatic's approximate misstatements in periodic reports and in the July 10, 1995 press release during the relevant time period arising from these improper revenue recognition practices. It also lists the related amounts of improperly recognized revenue. **FOOTNOTES** [2]:Sensormatic engaged in these improper revenue recognition practices for many years prior to fiscal year 1994. Sensormatic's shipping records indicate that the number of orders shipped and the amount of revenue recognized on the last day of the first, third, and fourth quarters of fiscal year 1993 substantially exceeded the daily average of the number of orders shipped and the amount of revenue recognized for the other days in the quarters. The last day of the third quarter of fiscal year 1993 is illustrative: On that day, Sensormatic shipped 1,692 orders, compared to a daily average number of orders shipped of 232, and recognized $10,351,360 in revenue, compared to a daily average amount of revenue of $506,900. ------------------------------------------------------------- | Amount of Net Income | Over/ | % Over/ | | Improperly as Reported |[Under] | [Under] | | Recognized by |Statement |Statement of | | Revenue Sensormatic | of Net |Net Income | | | Income | | ------------------------------------------------------------- |1994 $8.5 M $14.8 M [$0.8 M] [5.3 %] | | Q1 | ------------------------------------------------------------- |1994 $4.6 M $18.8 M [$1.9 M] [9.1 %] | | Q2 | ------------------------------------------------------------- |1994 $15.8 M $16.4 M $3.6 M 28 .1% | | Q3 | ------------------------------------------------------------- |1994 $15.5 M $22.0 M [$0.9 M] [3.8 %] | | Q4 | ------------------------------------------------------------- |1995 $12.8 M $20.1 M [$0.5 M] [2.2 %] | | Q1 | ------------------------------------------------------------- |1995 $13.8 M $25.3 M $0.3 M 1.2 % | | Q2 | ------------------------------------------------------------- |1995 $30.2 M $24.1 M $6.7 M 38.3 % | | Q3 | ------------------------------------------------------------- |1995 $29.3 M $18-$21M* $5.2 M 40.5 % | | Q4 | ------------------------------------------------------------- *Sensormatic's reported estimate in press release. During the period of the fraudulent scheme, Sensormatic filed with the Commission false and misleading Forms 10-Q and 10-K. During the same period, it also filed registration statements designed to raise money to finance acquisitions. These registration statements were false and misleading because they incorporated by reference one or more of the periodic reports identified above. These periodic reports and registration statements, including the financial statements therein, misstated the company's results of operations, including revenue and net income. They also falsely stated that the company recognized revenue upon shipment during the stated periods, whereas in fact the company intentionally and prematurely recognized revenue from shipments in the succeeding period or periods and did not comply with GAAP. Sensormatic also issued a press release on July 10, 1995 that materially overstated the preliminary estimates of Sensormatic's EPS for fiscal year 1995 and the fourth quarter of that year. In the press release, Sensormatic announced preliminary estimates of $0.23 to $0.27 EPS for the fourth quarter of fiscal year 1995, and of $1.21 to $1.25 EPS for the year, overstatements of 43.8% and 18.6% respectively, using the lower EPS figures in the release. Actual fiscal year 1995 EPS were $1.02 and fourth quarter EPS were $0.16. (h)Concealing the Scheme Sensormatic's accounting records were falsified by improperly recording revenue. These records, including the backdated documents reflecting shipments and the documents that prematurely recorded revenue on shipments to warehouses, concealed the out-of-period shipments and the other improper practices used to recognize revenue. Sensormatic's management also never disclosed these practices, which did not conform with GAAP, to the independent auditors. In fact, the CFO and the VP of Finance each signed the management representation letter in connection with the audit for fiscal year 1994. This letter was false because, among other things, it represented that all financial records had been provided to the auditors, that unaudited quarterly financial information had been prepared in conformity with GAAP, and that there were no irregularities involving management or employees who have significant roles in the internal control structures. Certain Sensormatic employees also took additional measures -- including withholding documents from the auditors and making false statements to them -- to conceal these practices from the auditors. For example, the VP of Finance directed that certain carrier-signed bills of lading, which would have revealed that revenue had been recognized in one quarter on shipments made past the end of that quarter, be withheld from the auditors; the VP of Finance then told the auditors that the bills of lading had been misplaced or lost. Also, during the fiscal year 1995 audit, the auditors questioned Sensormatic concerning the shipping terms in the contract discussed in Section III. A. 3. (e) above. The VP of Finance told the auditors that the contract's shipping terms were FOB Sensormatic although he had learned that they were FOB destination. In July 1995, the auditors discovered that this customer had not signed a standard Sensormatic contract in connection with an order it placed in the fourth quarter. After learning from the auditors that they would seek a written confirmation from the customer regarding the terms of the earlier contract, the VP of Finance, without the auditors' knowledge, obtained the customer's signature on a false confirmation he prepared indicating that the shipping terms were FOB Sensormatic. The VP of Finance provided the confirmation to the auditors. B.LEGAL ANALYSIS 1.Sensormatic Violated the Antifraud Provisions of the FederalSecurities Laws Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit a person from making misstatements or omissions of material fact or engaging in any scheme to defraud in connection with the purchase or sale of a security. Section 17(a) of the Securities Act prohibits such misstatements, omissions, or schemes in connection with the "offer or sale" of securities. Violations of Section 10(b) and Rule 10b-5 occur when an issuer makes material misstatements in registration statements, prospectuses, or periodic reports filed with the Commission and trading thereafter occurs in the issuer's securities. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). In addition, to violate Section 10(b) and Rule 10b-5, a defendant must act with scienter, Aaron v. SEC, 446 U.S. 680, 695 (1980), which the Supreme Court has defined as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). However, recklessness can be sufficient to establish scienter to impose liability under Section 10(b) and Rule 10b-5 thereunder in connection with filing false and misleading required periodic reports. See, e.g., IIT v. Cornfeld, 619 F.2d 909, 923 (2d Cir. 1980); Decker v. Massey-Ferguson, Ltd., 681 F.2d 111, 120 (2d Cir. 1982); Lanza v. Drexel & Co., 479 F.2d 1277, 1306 (2d Cir. 1973). For purposes of establishing that a corporation has the requisite scienter, the mental states of its officers may be imputed to it. SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1096 n. 16 (2d Cir. 1972). A fact is material if there is a substantial likelihood that a reasonable investor would consider the information to be important. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). Among the facts that may be considered material is the misrepresentation of a company's earnings. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969); Alna Capital Assocs. v. Wagner, 532 F. Supp. 591, 599 (S.D.Fla. 1982). Under certain circumstances, the improper recognition of revenue in contravention of GAAP may be considered material. See Fine v. American Solar King Corp., 919 F.2d 290, 301 (5th Cir. 1990). Sensormatic violated Section 10(b) and Rule 10b-5 by engaging in a scheme to fraudulently misstate its results of operations, including revenue and net income. As a result of the fraudulent scheme, Sensormatic filed materially false and misleading periodic reports. These periodic reports were false and misleading because they misstated the company's quarterly results of operations as a result of Sensormatic's improper recognition of revenue. In addition, the reports falsely stated that the company recognized revenue upon shipment, whereas in fact it intentionally and prematurely recognized revenue for shipments made in the succeeding period or periods, and did not comply with GAAP and its revenue recognition policy. Sensormatic also violated Section 10(b) and Rule 10b-5 by issuing the July 10, 1995 press release that materially overstated preliminary estimates of earnings results for the quarter ended June 30, 1995 and for fiscal year 1995. As a result of Sensormatic's fraudulent conduct, it was impossible for any reasonable investor to rely on the financial information reported by the company. Sensormatic violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder when it filed materially false and misleading registration statements. These registration statements incorporated by reference the materially false and misleading periodic reports discussed above, including the financial statements contained in them and also falsely stated that the company recognized revenue upon shipment, whereas in fact it intentionally and prematurely recognized revenue, and did not comply with GAAP and its stated revenue recognition policy. 2.Sensormatic Violated the Reporting Provisions of the Exchange Act Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers with securities registered under Section 12 of the Exchange Act, such as Sensormatic, to file annual and quarterly reports. The financial statements contained in these periodic reports must conform with Regulation S-X, which generally requires conformity with GAAP. 17 C.F.R.  210.4-01(a)(1). In addition, Exchange Act Rule 12b-20 requires that periodic reports filed with the Commission contain all information necessary to ensure that the statements made are not materially misleading. An issuer violates these provisions if it files a periodic report that contains materially false or misleading information. See, e.g., Laser Photonics, Inc., Securities Act Release No. 7463 (Sept. 30, 1997); and Spectrum Information Technologies, Inc., Securities Act Release No. 7426 (June 25, 1997). As discussed above, Sensormatic engaged in a fraudulent scheme wherein it filed materially false and misleading periodic reports. Consequently, Sensormatic violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder by disseminating to the public and filing with the Commission these periodic reports. Sensormatic's reporting violations deprived investors of accurate and reliable financial information. In particular, interim financial reporting, as reflected in quarterly reports on Form 10-Q, is an important part of the full disclosure principle underlying the federal securities laws because investors rely on, and react quickly to, quarterly results. Because interim financial statements are unaudited, the investment community places particular reliance on the issuer and its management to accurately report interim results. 3.Sensormatic Violated the Recordkeeping and Internal Controls Provisions of the Exchange Act Section 13(b)(2)(A) of the Exchange Act requires a company such as Sensormatic to make and keep books and records which accurately and fairly reflect its transactions and dispositions of assets. Section 13(b)(2)(B) of the Exchange Act requires Sensormatic to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that, among other things, transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP and to maintain the accountability of assets. Sensormatic's practice of recording revenue from out-of-period shipments involved the preparation of, among other things, inaccurately dated shipping documents. Such documents were integral to Sensormatic's ability to prepare its financial statements. By recording shipping dates and revenue inaccurately in its books and records, Sensormatic violated Section 13(b)(2)(A). Sensormatic also failed to devise and maintain internal accounting controls that assured that its financial statements were prepared in compliance with GAAP. Among other things, Sensormatic did not have internal controls in place to prevent and detect the resetting of the computer clock and to ensure the accuracy of shipping and revenue records. IV. Based on the foregoing, the Commission finds that Sensormatic violated Section 17(a) of the Securities Act, Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder. V. In view of the foregoing, the Commission finds that it is appropriate to impose the following relief as agreed to in the Offer. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Sensormatic cease and desist from committing or causing any violation, and any future violation, of Section 17(a) of the Securities Act, Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act, and Exchange Act Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary SERVICE LIST Rule 141 of the Commission's Rules of Practice provides that the Secretary, or another duly authorized officer of the Commission, shall serve a copy of the Order Instituting Proceedings on each person named as a party in the order or their legal agent. The attached Order Instituting Public Administrative Proceedings, Making Findings, and Issuing Cease-and-Desist Order has been sent to the following parties and other persons entitled to notice: The Honorable Brenda P. Murray Chief Administrative Law Judge Securities and Exchange Commission Mail Stop 11-6 450 Fifth Street, N.W. Washington, D.C. 20549 Securities and Exchange Commission Division of Enforcement 450 Fifth Street, N.W. Mail Stop 7-9 Washington, D.C. 20549 Attention: Sharon Zamore, Esq. Joseph I. Goldstein, Esq. Crowell & Moring, LLP 1001 Pennsylvania Avenue, N.W. Washington, D.C. 20004-2595 Attorney for Respondent Sensormatic Electronics Corporation Sensormatic Electronics Corporation c/o Joseph I. Goldstein, Esq. Crowell & Moring, LLP 1001 Pennsylvania Avenue, N.W. Washington, D.C. 20004-2595