UNITED STATES OF AMERICA
In the Matter of
SIGNAL TECHNOLOGY CORPORATION,
|ORDER INSTITUTING PROCEEDINGS, MAKING FINDINGS, AND IMPOSING CEASE-AND-DESIST ORDER|
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against respondent Signal Technology Corporation ("Signal Tech").
In anticipation of the institution of these cease-and-desist proceedings, Signal Tech 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 in which the Commission is a party, and without admitting or denying the Commission's findings contained herein, except that Signal Tech admits that the Commission has jurisdiction over it and the subject matter of these proceedings, Signal Tech consents to the issuance of this Order Instituting Proceedings, Making Findings and Imposing a Cease-and-Desist Order ("Order"), the entry of the findings and the cease-and-desist order set forth below.
On the basis of this Order and the Offer, the Commission makes the following findings:1
Signal Tech is a Delaware corporation currently based in Danvers, Massachusetts. During the relevant time period, Signal Tech's principal place of business was in Sunnyvale, California. Signal Tech designs and manufactures electronic systems that are used in defense, space and wireless communications applications. At all relevant times, Signal Tech's securities were traded on the American Stock Exchange and registered with the Commission pursuant to Section 12(b) of the Exchange Act, and the company was required to file reports with the Commission pursuant to Section 13(a) of the Exchange Act.
This matter concerns material overstatements of income in multiple reporting periods by Signal Tech. During the period from January 1996 through June 1998, Signal Tech's Keltec division prematurely recognized revenue, failed to record contract losses and failed to write down excess inventory. Signal Tech's former chairman and CEO, former CFO, and other former senior corporate officers, knew of and in multiple instances personally directed improper accounting practices.2 On several occasions the former chairman and other senior officers even dictated specific misleading entries to be made on Keltec's books. These practices concealed the extent of Keltec's losses and resulted in Signal Tech's misstating its net income in consolidated financial statements filed in each of its Forms 10-K and 10-Q during the thirty-month period.
On November 4, 1998, under new management, Signal Tech restated its financial results for the years ended December 31, 1996 and December 31, 1997, and for each quarter of those years and for the first quarter of 1998. The restatement showed that Signal Tech originally overstated its 1996 net income by 32%, and overstated its 1997 net income by 294%. Similarly, in its financial statements for the quarters ended March 31, 1996 through March 31, 1998, Signal Tech misstated its net income by 8% to 253%.
Keltec, one of the largest of Signal Tech's six divisions, produced approximately 25% of Signal Tech's total sales during 1996-1998. Keltec designed and produced power supply systems used in military, space and communications applications. A substantial portion of Keltec's business consisted of fixed price contracts, completed over several financial reporting periods. Under these contracts, Keltec bore the risk that the design and manufacture of the contract product might cost more than the contract price. During 1996 through the first half of 1998, the Keltec division incurred large cost overruns on many of its biggest contracts.
Signal Tech's former chairman pressured Keltec managers to improve profits and terminated those who did not meet the desired profit goals. For 1996, Keltec was required to produce twice the pre-tax profits it had achieved in 1995; and in 1997 and early 1998 it was also expected to increase its profits. During the thirty months beginning in January, 1996, Signal Tech's former chairman installed four successive presidents at the Keltec division, due to Keltec's continuing failure to meet profit goals.
Signal Tech's former management created a corporate atmosphere which encouraged managers to engage in improper accounting in an effort to improve Signal Tech's bottom line. Signal Tech's former chairman and other senior officers expressed scorn for accounting principles. When Signal Tech's CFO left in June 1997, the former chairman assumed many of the CFO's functions and made final accounting policy decisions for Signal Tech, even though he had no accounting expertise.
As a result of the pressure for profits at all costs and disdain for accounting principles by former senior officers of Signal Tech, all four of Keltec's presidents during this period, as well as Keltec's controller, knowingly allowed improper accounting practices at Keltec, as did the most senior officers of Signal Tech, including its former chairman, former CFO and former president. Moreover, Signal Tech's senior officers personally directed specific improper accounting practices and dictated misleading entries to be made on Keltec's books to overstate revenue and understate costs.
1. Failure Properly to Record Estimated Losses on Contracts at Keltec
Keltec improperly failed to record anticipated losses and decreased profit margins as it performed its long-term contracts. The division regularly calculated the anticipated profit or loss on each contract and circulated reports reflecting these figures to both Keltec and Signal Tech senior management. Under generally accepted accounting principles (GAAP), anticipated contract losses must be recorded in the periods in which they became known, and contract cost of sales figures must be adjusted to reflect decreased contract profit margins.3 By the end of the third quarter of 1996, however, Keltec had accumulated $338,000 in contract cost adjustments which had not been recorded. Almost 80% of that total was from an anticipated loss on a large contract for an Israeli company, Elisra. At year-end 1996, the unbooked loss on the Elisra contract had increased to approximately $370,000. Instead of recording the entire amount of the anticipated loss, Signal Tech's CEO and CFO created a reserve of only $200,000 for anticipated losses on the Elisra contract. The entire amount of reserve available to cover losses on Keltec's contracts was inadequate even to cover the full amount of the anticipated Elisra loss. As of year-end 1996, Keltec had failed to record $450,000 in cost of sales adjustments to reflect anticipated contract losses and decreased profit margins on contracts.
During 1997, Keltec continued its practice of failing to record contract cost of sales increases, under four different division presidents. By the end of the first quarter of 1997, the total amount of unrecorded contract cost of sales adjustments at Keltec had grown to over $1 million, including $618,000 relating to the Elisra contract, and more than $300,000 on two Raytheon contracts. The unrecorded costs remained at that level through the second quarter. During the third quarter, Keltec continued not to record any cost increases on some contracts, and for others, began recording only a portion of the total anticipated loss. The practice of spreading losses over reporting periods was inconsistent with GAAP, which require that the entire amount of a known loss be recorded in the period in which it first becomes known. Spreading the contract losses distorted Keltec's and Signal Tech's quarterly financial results.
At the end of the third quarter of 1997, Keltec failed to record $1 million in contract cost of sales increases, thereby improving its profit. Some of the cost increases were improperly eliminated by combining unprofitable contracts with other, profitable contracts. For others, Keltec did not book an increase in cost of sales because its management stated that the amounts were "not material," or the contracts were "under review." Under GAAP, neither of these purported justifications is a valid basis for failure to record known cost increases on contracts.
At year-end 1997, Keltec failed to record approximately $350,000 in contract cost of sales increases. During the first and second quarters of 1998, under Keltec's fourth president in the period, Keltec ceased its regular calculation of contract estimates at completion, so that it became difficult to determine whether a contract's profit margin had changed. Instead, Keltec's president personally dictated the cost of sales figures to be recorded on contracts each month.
2. Improperly Recognized Revenue
Beginning in the second quarter of 1996 and continuing through the end of 1997, Keltec improperly recognized revenue on advance payments by customers (such as payments to be used to purchase materials with which to manufacture a product) and on improper ship-in-place transactions. Neither of these practices complied with GAAP, which requires that revenue be recognized only when it is earned and realized or realizable.4
During 1996 and 1997, management approved recognition of revenue for the sale of goods which had not yet been shipped from Keltec. These "bill and hold" transactions did not meet GAAP criteria for recognition because Keltec's management, rather than the customer, had requested that the bill be sent before product was delivered. S.E.C. Accounting and Auditing Enforcement Release No. 108 (August 5, 1986). As one foreign customer noted in a June 28, 1996 fax agreeing to one such request by Keltec's management, "[We] cooperate Keltec be able to achieve its sales goal at the first half of this year, in condition it does not affect the article 3 (payment)."[sic] Keltec's president initialed this response and signed off on booking the transaction as revenue. Keltec's management also allowed revenue to be taken on advance payments, which were inaccurately characterized as payments for services rendered.
Keltec improperly recognized revenue in each of the last three quarters of 1996, in amounts totaling $934,000, $639,000 and $491,000 respectively. During each quarter of 1997, Keltec improperly recognized revenue in amounts totaling $915,000, $149,000, $471,0000 and $231,000, respectively.
3. Failure to Write Off Worthless Inventory
Keltec's third improper accounting practice, which involved keeping worthless inventory on the books rather than writing it off, resulted in further overstatement of Keltec's profits. By the fourth quarter of 1996, on many contracts Keltec had built up more units in inventory (called "work-in-process" or "WIP") than were needed to fill its backlog of customer orders. Under GAAP, if the excess WIP on a contract cannot be otherwise used by the company, it must be written off as part of the cost of sales for that contract and a loss must be recorded in the current period.5 Keltec's management did not write off WIP in excess of backlog. In fact, there was no regular process by which the value of WIP on open jobs was even compared to backlog, so that there was no way of determining what should be written off. Instead, WIP remained recorded on Keltec's balance sheet as work-in-process, a component of inventory. This practice caused Keltec's costs of sales to be understated and its profits overstated. During the fourth quarter of 1996, Keltec failed to write off $476,000 in excess WIP costs.
When contracts were completed, Keltec continued its improper accounting treatment of WIP. Under GAAP, WIP on closed jobs must be written off as soon as all goods called for by the contract have been shipped.6 From at least March 1997 through March 1998, Keltec's controller instead improperly amortized the inventory write-down over several financial reporting periods. Keltec failed to write off material amounts of excess WIP costs during each quarter from the fourth quarter of 1996 through the first quarter of 1998. For the four quarters of 1997, Keltec failed to write off excess WIP in amounts totaling $69,000, $619,000, $321,000 and $180,000, respectively. For the first quarter of 1998, Keltec failed to write off WIP in excess of backlog totaling $797,000.
4. Additional Accounting Improprieties
Beginning in the third quarter of 1997, Keltec reduced its overhead rate from 200% to 175%, resulting in a reduction in its cost of sales. There was no basis in reality for this reduction because Keltec had never achieved a 175% overhead rate, nor did its overhead costs ever actually decrease to that 175% rate during the period it was using the rate to calculate its costs. The overhead rate reduction resulted in Keltec's profits being overstated by approximately $240,000 during September 1997 through June 1998.
Signal Tech and Keltec managers caused reductions to reserves which had no support. At the end of the first quarter of 1997, Signal Tech reduced its reserve for contract losses by $210,000; no existing documentation sets forth any basis for this reduction. By the end of 1997, Signal Tech had completely eliminated its reserve for contract losses. This occurred even though Keltec had no reserve for contract losses at any time during 1997, and at the end of that year, Keltec still had unrecorded anticipated losses on contracts. At year end 1997, Keltec reduced its reserve for excess and obsolete inventory by $100,000, without support. At the end of the first quarter of 1998, Keltec reduced its reserve for warranty liabilities by $121,000, without support.
5. Management's Response to Reports of Accounting Improprieties
During the first half of 1998, Signal Tech's board of directors searched for and hired a new CEO, who took over that position on June 1, 1998. In April 1998, Keltec replaced its former controller with a certified public accountant. The new controller determined that Keltec might have over $3 million in unrecorded losses relating to WIP. He also uncovered Keltec's improper revenue recognition practices and its failure to record contract losses. Keltec's then-president dismissed the controller's conclusions and attempted to bar him from communicating them to Signal Tech's new CEO. When the new CEO nevertheless was made aware of the issues at Keltec and informed Signal Tech's former chairman of them, the former chairman insisted that he retract his statements and indicated his intent to fire the new CEO. The new CEO, however, fired Keltec's former president and Signal Tech's board approved the new CEO's recommendation that an internal audit be conducted. The internal audit of Keltec revealed unrecorded losses totaling approximately $9.8 million. On August 4, 1998, after the completion of the internal audit, Signal Tech's former chairman resigned at the request of Signal Tech board members.
Signal Tech's board of directors authorized the company's outside auditors to conduct a re-examination of Keltec's financials. On November 4, 1998, Signal Tech filed an amended 10-K for the year ended December 31, 1997. The amended 10-K restated financial results for the years ended December 31, 1996 and December 31, 1997, as well as restating financial results for all eight quarters in 1996 and 1997. Signal Tech also filed an amended 10-Q for the quarter ended March 31, 1998.
6. Financial Effect of Accounting Improprieties
Keltec's improper accounting practices caused Signal Tech's consolidated financials for each quarter of 1996 to be materially misstated. According to the restated financial results, Signal Tech understated its net loss by 8% in the first quarter of 1996 and understated its net income by 23% in the second quarter. In the third quarter of 1996, Signal Tech overstated its net income by 64%. Signal Tech overstated its net income after taxes for year end 1996 by 33%, reporting $2,245,000, rather than $1,698,000. These results were reported in Signal Tech's Form 10-K, filed with the Commission on March 31, 1997.
During the first, second and third quarters of 1997, Signal Tech overstated its net income by approximately 253%, 74%, and 67%, respectively. Signal Tech's 1997 Form 10-K, filed with the Commission on March 31, 1998, misstated the company's net income after taxes for year end 1997 by approximately $1 million: Signal Tech reported $338,000 in net income after taxes although the company actually suffered a net loss after taxes of $657,000. Signal Tech overstated its net profits after taxes for the first quarter of 1998 by approximately 82%, in its Form 10-Q filed on May 15, 1998.
1. Signal Tech Violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 Thereunder
Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 require issuers of registered securities to file annual and quarterly reports with the Commission. It is implicit in this requirement that the information provided be accurate. See United States v. Bilzerian, 926 F.2d 1285, 1298 (2d Cir.), cert. denied, 502 U.S. 813, 112 S. Ct. 63 (1991); SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975). Regulation S-X requires that financial statements filed with the Commission pursuant to Section 13(a) of the Exchange Act be prepared in accordance with GAAP or such statements will be presumed to be misleading or inaccurate. In addition, Exchange Act Rule 12b-20 requires that these periodic reports contain all information necessary to ensure that statements made in them are not materially misleading. The issuer reporting provisions are violated when false and misleading reports are filed. SEC v. Falstaff Brewing Corp., 629 F.2d 62, 67 (D.C. Cir. 1980). No showing of scienter is necessary to establish a violation of Section 13(a) or Rules 12b-20, 13a-1, or 13a-13. See SEC v. McNulty, 137 F.3d 732, 740-41 (2d Cir. 1998); SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1167 (D.C. Cir. 1978); SEC v. Wills, 472 F. Supp.1250, 1268 (D.D.C. 1978); In re Curtis L. Dally, Exchange Act Rel. No. 39144, (September 29, 1997), 1997 SEC LEXIS 2026.
Signal Tech filed Forms 10-K for the years ended December 31, 1996 and December 31, 1997 that materially misstated the company's income by 33% and 294%, respectively. The company improperly reported a net profit for the year 1997, when in fact it had incurred a loss. Signal Tech filed Forms 10-Q for each of the first three quarters of 1996 and 1997 and the first quarter of 1998, which materially misstated the company's income by 8% to 253%. Accordingly, Signal Tech violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
2. Signal Tech Violated Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act
Section 13(b)(2) of the Exchange Act states, in pertinent part, that every reporting company must: (A) make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the issuer; and (B) devise and maintain a system of internal controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit the preparation of financial statements in conformity with GAAP. These provisions require an issuer to employ and supervise reliable personnel, to maintain reasonable assurances that transactions are executed as authorized, to properly record transactions on an issuer's books and, at reasonable intervals, to compare accounting records with physical assets. SEC v. World-Wide Coin Investments, Ltd., 567 F. Supp. 724, 750 (N.D. Ga. 1983). Sections 13(b)(2)(A) and 13(b)(2)(B) do not require a showing of scienter. Id., at 751.
Signal Tech violated Section 13(b)(2)(A) of the Exchange Act by failing to maintain accurate records concerning its revenues, costs and net income. It failed to record contract costs, failed to write off excess inventory, and recognized revenue improperly. Signal Tech's inaccurate and false records were not isolated or unique instances because they were improperly maintained for multiple reporting periods, from January 1996 through June 1998. Accordingly, Signal Tech violated Section 13(b)(2)(A) of the Exchange Act.
In addition, Signal Tech violated Section 13(b)(2)(B) of the Exchange Act by failing to implement procedures reasonably designed to prevent accounting irregularities. Signal Tech failed to ensure that proper reviews and checks were in place to ensure that its Keltec division did not engage in accounting improprieties. It failed to ensure that transactions were reported in accordance with its own policies and with GAAP. During the period from June 1997 through the first quarter of 1998, Signal Tech failed to employ a CFO and the CEO, who was not an accountant, exercised final control over accounting treatment at the company, thus eliminating the segregation of duties which is required for adequate controls. Accordingly, Signal Tech violated Section 13(b)(2)(B) of the Exchange Act.
In determining to accept the Offer, the Commission considered remedial acts undertaken by Signal Tech and cooperation afforded the Commission staff.
In view of the foregoing, the Commission deems it appropriate to accept the Offer submitted by Signal Tech and to impose the cease-and-desist order agreed to in the Offer.
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Signal Technology 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 12b-20, 13a-1 and 13a-13 thereunder.
By the Commission.
Jonathan G. Katz
|1||The findings herein are made pursuant to the Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.|
|2||Simultaneously with the institution of these proceedings, the Commission is filing a civil injunctive action for violations of the antifraud provisions of the federal securities laws against Signal Tech's former chairman and CEO, its former CFO, the former controller of Signal Tech's Keltec division, and the four individuals who served as presidents of Keltec during the period in which the accounting fraud took place.|
|3||Statement of Position ("SOP") 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts. FASB Statement of Financial Accounting Standards No. 5 ("FAS5"), Accounting for Contingencies. Accounting Research Bulletin No. 45, Long-Term Construction-Type Contracts ("ARB 45"). Consistent with GAAP, Signal Tech's corporate accounting policy required that estimated losses on contracts be recognized in full in the period in which they became known.|
|4||FASB Statement of Financial Accounting Concepts No. 5 ("CON 5"), Recognition and Measurement in Financial Statements of Business Enterprises.|
|5||Accounting Research Bulletin No. 43 ("ARB 43"), Chapter 4, Inventory Pricing, Statement 5.|
|6||ARB 43, Chapter 4, Inventory Pricing, Statement 4.|
|Home | Previous Page||