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U.S. Securities and Exchange Commission

Before the

Release No. 43068 / July 24, 2000

Release No. 1287 / July 24, 2000

File No. 3-10258

                              : ORDER INSTITUTING CEASE-AND-
      In the Matter of        : DESIST PROCEEDINGS PURSUANT
                              : TO SECTION 21C OF THE
                              : OF 1934 AND FINDINGS AND
        Respondent.           : ORDER OF THE COMMISSION


The Commission deems it appropriate to institute public administrative proceedings pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Respondent Guilford Mills, Inc. violated Sections 13(a) and 13(b)(2) of the Exchange Act and Rule 13a-13 thereunder.


In anticipation of the institution of these administrative proceedings, Respondent has submitted an Offer of Settlement which the Commission has determined to accept. Solely for purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, Respondent, without admitting or denying the matters set forth herein, consents to the issuance of this Order Instituting Cease-and-Desist Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934 and Findings and Order of the Commission ("the Order"), and to the entry of the findings, and the imposition of the remedial sanctions, set forth below.


The Commission finds the following:1


1. Respondent

Guilford Mills, Inc. ("Guilford") is a Delaware corporation with headquarters in Greensboro, North Carolina. Guilford manufactures warp knit and knit lace fabrics at various facilities located in North America and Europe. Guilford's common stock is registered with the Commission under Section 12(b) of the Exchange Act and is traded on the NYSE. For its fiscal year ended September 27, 1998, Guilford reported total revenues of $894.5 million and net income of $30.2 million. As of September 30, 1998, Guilford had approximately 23.2 million shares of common stock outstanding.

One of Guilford's subsidiaries is Hofmann Laces, a textile operation with two manufacturing facilities located in upstate New York, which Guilford acquired in January 1996. Before the company was acquired by Guilford, Hofmann Laces was a privately held company. Since Guilford acquired Hofmann Laces, the financial results of Hofmann Laces have been included in the consolidated financial statements contained in Guilford's periodic reports filed with the Commission.

2. Timothy J. Gaffney

Timothy J. Gaffney was the Controller of Hofmann Laces from May 1986 until September 1998. During that period, Gaffney's responsibilities included maintaining the accounting books and records of Hofmann Laces and preparing the financial statements of Hofmann Laces.2

3. Guilford's Insufficient Internal

Accounting Controls

Following Guilford's acquisition of Hofmann Laces in January 1996, Guilford did not integrate the general ledger accounting system of Hofmann Laces into Guilford's existing accounting system. No one from Guilford's accounting department reviewed the general ledger, general journal, or subsidiary ledgers (e.g., accounts payable) of Hofmann Laces until after Gaffney resigned from the company in September 1998. 3 Moreover, Guilford's internal audit staff did not perform any on-site review or inspection of the accounting system and control environment at Hofmann Laces. Although Guilford's independent auditors performed a separate year-end audit of the financial statements of Hofmann Laces, these auditors were not engaged separately to examine or review the accounting system and internal controls at Hofmann Laces.

4. Guilford's Inaccurate Books and Records and

False and Misleading Quarterly Filings on Form 10-Q

Between January 1997 and August 1998, Gaffney made a series of false journal entries to the general ledger of Hofmann Laces. Gaffney generally made these entries while "closing" the books for Hofmann Laces at the end of a particular month. None of the false entries had a proper accounting justification, and none was supported by any underlying documentation. In a typical false entry, Gaffney would decrease a trade accounts payable account in a round-dollar amount ranging from $500,000 to $1.8 million, and credit a purchase account (cost of sales) in the same amount, which increased earnings. Gaffney's false entries in the aggregate had the effect of materially understating accounts payable and materially overstating earnings at Hofmann Laces.

Gaffney's false journal entries did not affect the financial results reported in Guilford's financial statements for the fiscal year ended September 28, 1997, because Gaffney reversed the false entries by the end of the fiscal year. However, during the first three quarters of Guilford's fiscal year ended September 27, 1998, Gaffney did not reverse most of his false entries, and thus Guilford's financial statements for those quarters, which were included in Guilford's quarterly reports on Form 10-Q, were materially misstated. Specifically, operating income from Guilford was overstated (before other adjustments) by $2,675,000 (or 18%) for the fiscal quarter ended December 28, 1997, by $3,605,000 (or 20%) for the fiscal quarter ended March 29, 1998, and by $2,725,000 (or 12%) for the fiscal quarter ended June 28, 1998. The following table summarizes the effects of Gaffney's false journal entries, as restated:4

Guilford Mills, Inc. Operating Income (in 000s)

Quarter ended Reported Restated Difference % change
12/28/97 $ 14,687 $ 12,734 $ 1,953 - 13.3%
3/29/98 17,820 17,156 664 - 3.7%
6/28/98 22,003 22,520 517 + 2.3%

During the period when Gaffney was making these false entries in the general ledger of Hofmann Laces, he was also sending monthly reporting packages for Hofmann Laces to Guilford's headquarters in Greensboro, North Carolina. Gaffney's monthly reporting packages included formal financial statements, supplemental schedules, and sales and inventory information. Certain of these reports indicated, among other things, that inventories at Hofmann Laces were rapidly increasing at the same time that its accounts payable were rapidly decreasing. This apparent divergence was a direct result of Gaffney's false journal entries, though Guilford's personnel apparently believed that the divergence between Hofmann Laces' increasing inventories and its decreasing accounts payable was due, at least in part, to intercompany inventory purchases by Hofmann Laces from Guilford, which were reflected not in accounts payable but rather in a separate line item for intercompany transfers.

In any case, the false entries went undetected because, among other things, Gaffney retained sole and exclusive control over the Hofmann Laces general ledger, because no one at Guilford reviewed Gaffney's entries or adjustments to Hofmann Laces' general ledger, and because Guilford had not yet integrated the Hofmann Laces general ledger accounting system into its own.

5. Guilford's Discovery of the False Entries

Gaffney resigned his position and left Hofmann Laces in late September 1998. On Monday, October 26, 1998, after the stock market closed, Guilford issued a press release announcing that it had uncovered "potential accounting irregularities" at Hofmann Laces. The press release further announced that, as a result of the irregularities, operating income for Hofmann Laces appeared to have been overstated by approximately $10 million to $11 million, having a net effect on the company's consolidated pretax earnings in the range of $4.3 million to $6.5 million. Over the remainder of that week, the market price of Guilford's common stock experienced a short-term decline of approximately 23%, from $16.25 to $12.50 per share. On November 24, 1998, in a press release announcing its operating results for the fiscal quarter and fiscal year ended September 27, 1998, Guilford also announced that it would restate its financial results for the first three quarters of its fiscal year ended September 28, 1998.


Exchange Act Section 13(a) and Rule 13a-13 thereunder require issuers of registered securities to file quarterly reports with the Commission on Form 10-Q. Courts have uniformly held that it is implicit in this requirement that the information reported in such periodic reports be accurate. See, e.g., SEC v. Savoy Indus., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Exchange Act Section 13(b)(2)(A) requires issuers to "make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer," and Exchange Act Section 13(B)(2)(B) requires issuers to devise and maintain an adequate system of internal accounting controls. 15 U.S.C. § 78m(b)(2).

Guilford violated Exchange Act Section 13(a) and Rule 13a-13 because it filed with the Commission three periodic reports on Form 10-Q which contained materially misstated financial statements. Guilford also violated Exchange Act Section 13(b)(2)(A) and (B) because its books and records did not accurately and fairly reflect its transactions and dispositions, and because it failed to implement and maintain adequate internal accounting controls following its acquisition of Hofmann Laces. Guilford allowed a single individual to control access to Hofmann Laces' books and records without sufficient checks to ensure that his activities were proper, at a time when Guilford had not yet integrated the general ledger of Hofmann Laces into Guilford's existing system.



Based on the above, the Commission finds that Respondent Guilford Mills, Inc. violated Exchange Act Sections 13(a) and 13(b)(2)(A) and (B) and Exchange Act Rule 13a-13.



Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Guilford Mills, Inc. cease and desist from committing or causing any violation of, and committing or causing any future violation of, Exchange Act Sections 13(a) and 13(b)(2)(A) and (B) and Exchange Act Rule 13a-13.

By the Commission.

Jonathan G. Katz


1 The findings herein are not binding on anyone other than Guilford.

2 In a separate civil action filed simultaneously with this proceeding, Timothy J. Gaffney consented to the entry of an order by the court pursuant to Section 21(d) of the Exchange Act enjoining him from future violations of the Exchange Act Section 10(b) and Rule 10b-5 and ordering him to pay a $25,000 civil penalty. SEC v. Timothy J. Gaffney, Civil Action No. 1:00CV01725 (RMU) (D.D.C., filed July 24, 2000).

3 Prior to August 1998, no one had access to Hofmann Laces' general ledger without Gaffney's knowledge and approval. The general ledger was kept in a fireproof safe in Gaffney's office.

4 The difference between Guilford's reported and restated operating income for the 3 affected quarters was less than the amount by which Gaffney overstated income at Hofmann Laces. This is because Guilford, in restating its operating income, recalculated and reduced certain incentive bonuses payable to officers and employees based on the lower actual earnings of the company.