UNITED STATES OF AMERICA
SECURITIES EXCHANGE ACT OF 1934
ACCOUNTING AND AUDITING ENFORCEMENT
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted against Boston Scientific Corporation ("Boston Scientific") pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act").
In anticipation of the institution of these proceedings, Boston Scientific has submitted an Offer of Settlement ("Offer"), 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 to which the Commission is a party, and without admitting or denying the findings, except those findings pertaining to the jurisdiction of the Commission over it and over the subject matter of these proceedings, which Boston Scientific admits, Boston Scientific by its Offer consents to the entry of this Order Instituting Proceedings Pursuant to Section 21C of the Exchange Act, Making Findings, and Imposing Cease-And-Desist Order ("Order").
On the basis of this Order and the Offer submitted by Boston Scientific, the Commission makes the following findings:
A. Respondent and Related Entity
Boston Scientific Corporation is a Delaware corporation headquartered in Natick, Massachusetts, that develops, manufactures, and markets medical devices. Boston Scientific's securities are registered with the Commission pursuant to Section 12(b) of the Exchange Act, and its common stock is listed on the New York Stock Exchange. Boston Scientific has a December 31 fiscal year end.
2. Related Entity
Boston Scientific Japan, KK ("Boston Japan") is a Japanese corporation headquartered in Tokyo, Japan, and was, at all relevant times, a wholly owned subsidiary of Boston Scientific. It sells and distributes medical devices to hospitals in Japan through a network of independent distributors. In 1997 and 1998, Boston Japan's net sales constituted approximately 16-18% of Boston Scientific's overall sales.
This matter involves false sales recorded by Boston Japan, which resulted in Boston Scientific's material overstatements of net income, and understatements of net losses, in quarterly and annual reports for the periods ended March 31, 1997, through June 30, 1998. In 1997 and 1998, Boston Japan recorded thousands of false sales collectively totaling more than $75 million. Boston Japan submitted its false sales and earnings data to Boston Scientific, which then incorporated those figures in its consolidated financial statements that were filed with the Commission. As a result, Boston Scientific materially overstated its net income and/or understated its net losses for all four quarters in 1997, the fiscal year ended December 31, 1997, and the first two quarters in 1998, by amounts ranging from 10% to 46% of net income. In addition, Boston Japan's internal controls suffered from material weaknesses in that they failed to prevent or detect the false sales activity resulting from management and distributor collusion at Boston Japan. As a result, Boston Scientific violated the issuer reporting, record keeping and internal controls provisions of the Exchange Act.
2. Boston Japan's Fraudulent Salesand Boston Scientific's Restatement
Beginning at least as early as 1996 and continuing through the third quarter of 1998, employees of Boston Japan, including the former president, carried out a scheme to record false sales to independent distributors in order to boost Boston Japan's sales numbers. While the scheme began at least as early as 1996, it increased dramatically in 1997 and 1998 as a result of efforts by Boston Japan employees to meet or exceed previously set sales goals. More than forty Boston Japan employees and approximately 143 independent distributors eventually became involved in the scheme.
Boston Japan employees used a variety of techniques to perpetrate and cover up the fraudulent sales of medical devices, often colluding with the independent distributors. In certain cases, Boston Japan sales managers leased commercial warehouses, recorded false sales to distributors, and shipped the goods to the leased warehouses. To mask the fact that the distributors never paid for the goods, the sales managers eventually issued credits to the distributors and then recorded false sales of the same goods to other distributors, without ever moving the goods out of the leased warehouses. Over time, approximately 76% of Boston Japan's false sales were shipped to these leased warehouses. In other cases, sales managers issued purchase orders, shipped goods to cooperating distributors and booked revenue upon shipment of the goods when, in fact, the distributors never intended to pay for the goods and eventually returned them for credit several months later.
In some instances described above, Boston Japan employees went so far as to record sales to distributors that were not even involved in the medical device business, but that had agreed with Boston Japan sales managers to collude in the fraud. Some false sales were made to distributors that never resold any of the goods and never paid Boston Japan for any purported sales. The sales managers and cooperating independent distributors further colluded to cover up false sales by falsely confirming the legitimacy of the sales to Boston Scientific's auditors.
Boston Scientific discovered the false sales activity at Boston Japan in the fall of 1998. Boston Scientific's corporate finance function, with the benefit of a new management information system, highlighted a number of issues at Boston Japan, including a cash flow problem and a high rate of product returns. As a result, Boston Scientific requested that its outside auditors confirm outstanding receivables, which led to the discovery of the fraud. On November 3, 1998, Boston Scientific publicly announced the discovery of accounting irregularities in the operations of Boston Japan. On February 23, 1999, after determining that the total amount of improperly recognized revenue was more than $75 million, and after consulting with staff of the Commission's Office of the Chief Accountant, Boston Scientific restated its financial statements for all of 1997 and for the first three quarters of 1998.1
3. Boston Japan's False Sales Caused Boston Scientific's Material Misstatements in Periodic Reports
The booking of revenue based on false sales by Boston Japan caused Boston Scientific to make material misstatements in its quarterly reports on Forms 10-Q for all of 1997 and the first two quarters of 1998, and in its annual report on Form 10-K for 1997. Specifically, Boston Scientific overstated its net income or understated its net losses in these periodic reports filed with the Commission as follows:
Net Income Summary (thousands)
* Reported and restated net income is before the cumulative effect of a change in accounting.
4. Boston Scientific Failed to Maintain Accurate Books and Records
Boston Japan failed to maintain accurate books and records, which resulted in Boston Scientific's misstatements of net income in 1997 and 1998. In its books and records, Boston Japan recorded thousands of false sales transactions totaling more than $75 million to independent distributors. The recording of the false sales caused Boston Japan's books, records, and accounts to reflect inaccurately its transactions. As a result, Boston Scientific failed to maintain accurate books and records.
5. Boston Japan Failed to Maintain an Adequate System of Internal Controls
Boston Japan failed to maintain an adequate system of internal controls. Boston Japan's records did not properly track accounts receivable, cash receipts and product returns. Among other things, certain of Boston Japan's customer records contained excessive credits and did not indicate whether such credits were due to cash receipts or product returns. Without proper documentation of product returns, it was impossible for Boston Scientific or its auditors to determine whether old receivables were actually being paid or inventory was simply being returned and resold. The material weaknesses in Boston Japan's internal controls prevented detection of the false sales activity which resulted in the material misstatements of net income described above. Boston Scientific failed to ensure that Boston Japan maintained an adequate system of internal controls.
C. Legal Discussion of Violations
1. Violations of Section 13(a) of the Exchange Act
Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder require issuers whose securities are registered with the Commission pursuant to Section 12 of the Exchange Act to file periodic and other reports with the Commission. The information contained in periodic reports must be accurate and complete. United States v. Bilzerian, 926 F.2d 1285, 1298 (2d Cir. 1991) (citing SEC v. Savoy Indus. Inc., 587 F.2d 1149 (D.D.C. 1978)); SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975) (requirement that issuer file reports under Section 13(a) embodies the requirement that such reports be true and correct). No showing of scienter is necessary to establish a violation of Section 13(a). SEC v. McNulty, 137 F.3d 732, 741 (2d Cir. 1998); Savoy Indus., Inc., 587 F.2d at 1167 (holding no showing of scienter required for Section 13(d)(1) violation because it is a reporting provision).
By virtue of the conduct described above, Boston Scientific committed violations of Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder because it filed periodic reports with the Commission containing materially inaccurate information. Specifically, Boston Scientific materially overstated its net income or understated its net losses in its annual report on Form 10-K for 1997 and quarterly reports on Forms 10-Q for all of 1997 and the first two quarters of 1998.
2. Violations of Section 13(b) of the Exchange Act
Section 13(b)(2)(A) of the Exchange Act requires an issuer to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect its transactions. No showing of scienter is necessary to establish a violation of Section 13(b)(2)(A). SEC v. World-Wide Coin Investments, Ltd., 567 F.Supp. 724, 749 (N.D. Georgia, 1983). By virtue of the conduct described above, Boston Scientific committed violations of Section 13(b)(2)(A) of the Exchange Act because its books, records and accounts with respect to its Japanese subsidiary did not accurately and fairly reflect its transactions. Specifically, Boston Scientific's books, records and accounts with respect to Boston Japan contained thousands of instances of improperly recorded sales from 1997 through the third quarter of 1998, representing more than $75 million in improperly recognized revenue.
Section 13(b)(2)(B) of the Exchange Act requires every reporting company to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles. No showing of scienter is necessary to establish a violation of Section 13(b)(2)(B). World-Wide Coin, 567 F.Supp. at 751. Boston Japan's internal controls suffered from "material weaknesses,"2 because they did not properly track accounts receivable, cash receipts and product returns, thereby preventing timely detection of the fraudulent sales reporting. By failing to ensure that its subsidiary devised and maintained an adequate system of internal controls, Boston Scientific violated Section 13(b)(2)(B).
Based on the foregoing, the Commission finds that Boston Scientific committed violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder, and deems it appropriate to accept the Offer of Settlement submitted by Boston Scientific and to issue the cease-and-desist order specified herein.
In determining to accept the Offer, the Commission considered remedial acts promptly undertaken by Boston Scientific and cooperation afforded the Commission staff.
Accordingly, IT IS ORDERED, pursuant to Section 21C of the Exchange Act, that Boston Scientific Corporation cease and desist from committing or causing any violation and any future
violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder.
By the Commission.
Jonathan G. Katz
1 Boston Scientific accounted for $6,871,000 in false sales that occurred prior to 1997 by writing that amount off as bad debt in its restated selling, general and administrative expenses for 1997. Further, although false sales occurred in the third quarter of 1998, the existence of irregularities was discovered before Boston Scientific's quarterly report for that period was filed on November 16, 1998. Although reported revenues for the quarter ended September 30, 1998, were not restated, the company restated its earnings for the quarter to remove a $79 million charge for prior periods that had been taken in that quarter to address the fraudulent sales.
2 A material weakness in internal control is defined in generally accepted auditing standards as:
a reportable condition in which the design or operation of one or more of the internal control components does not reduce to a relatively low level the risk that misstatements caused by error or fraud in amounts that would be material in relation to the financial statements being audited may occur and not be detected within a timely period by employees in the normal course of performing their assigned functions. [See AICPA Professional Standards, AU 325.15].