UNITED STATES OF AMERICA
In the Matter of
Serologicals Corporation, Inc.
|ORDER INSTITUTING PUBLIC PROCEEDINGS PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKINGFINDINGS AND IMPOSING CEASE- AND-DESIST ORDER|
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Serologicals Corporation ("Serologicals" or "the Company").
In anticipation of the institution of these proceedings, Serologicals has submitted an Offer of Settlement, which Offer 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 in which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. § 201.100 et seq., Serologicals admits the jurisdiction of the Commission over it and the subject matter of these administrative proceedings and consents to the entry of this Order Instituting Public Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing Cease-and-Desist Order ("Order"), without admitting or denying the Commission's findings, except as for those contained in paragraph III.A. below, which are admitted.
Accordingly, IT IS HEREBY ORDERED THAT proceedings pursuant to Section 21C of the Exchange Act be, and hereby are, instituted.
On the basis of this Order and the Offer of Settlement by Serologicals, the Commission makes the following findings1:
A. During all relevant times, Serologicals was an Atlanta-based supplier of specialty human antibodies and other blood-related products and services to various healthcare companies. The Company's securities were registered with the Commission pursuant to Section 12(g) of the Exchange Act.
SEROLOGICALS IMPROPERLY RECOGNIZED REVENUE FROM BILL-AND-HOLD SALES
B. On December 29, 1998 Serologicals acquired from a large, international healthcare company the Pentex Blood Proteins Division ("Pentex"), which Serologicals renamed Serologicals Proteins. This subsidiary supplied a broad line of purified animal and human blood proteins to biopharmaceutical companies.
C. During 1999, Serologicals Proteins continued a bill-and-hold relationship with one of its largest customers that had originated at Pentex in 1997. Pursuant to this relationship, Serologicals Proteins improperly recognized revenue when it invoiced the customer and prior to actually shipping the product.2 As the arrangement existed in 1999, Serological Proteins periodically sent pre-purchase product samples to the customer for testing. If the customer did not reject a sample within ten to twelve weeks after receipt, Serologicals Proteins automatically sent an invoice to the customer for the bulk product from which that sample came--referred to as a "Lot"--and recognized a sale of the Lot.
D. Serologicals Proteins' practice of recognizing revenue when it sent an invoice to the customer failed to comply with GAAP because the risks and rewards of ownership of the Lots had not yet passed to the customer. See In re Stewart Parness, AAER No. 108 (August 5, 1986), 36 SEC Docket 395. Here, the customer retained the right to reject any pre-purchase product sample and obtain a full refund after paying an invoice if the sample did not satisfy the customer's acceptance criteria. Also, the customer never specified a fixed delivery schedule for the Lots and did not make a fixed commitment to purchase any particular Lot. Moreover, until the customer requested shipment, Serologicals Proteins stored the Lots at a warehouse where it leased space. Finally, the customer's purchase orders specified "F.O.B. Shipping," suggesting that the risk of loss did not shift to the customer until the goods were delivered to the shipper. See U.C.C. § 2-319(1) (2000).
E. Including improper revenue from Serologicals Proteins' bill-and-hold sales caused Serologicals to overstate its consolidated net income by $316,000 in the second quarter of 1999 and understate its net loss by $401,000 in the third quarter of 1999.
SEROLOGICALS IMPROPERLY RECOGNIZED REVENUE WHEN TITLE TO THE GOODS HAD NOT PASSED TO THE CUSTOMER
F. Serologicals failed to comply with GAAP by recognizing $213,000 in net income from a sale of blood products during the third quarter of 1999 because title to those goods had not yet passed to the customer. Serologicals sent an invoice to the customer and recognized the sale while the goods were being held at a warehouse where Serologicals leased space. At that time, the warehouse personnel were preparing the goods for shipment, but the customer's designated shipper had not yet taken possession of those goods. Because title to those goods would not pass until the shipper took possession, Serologicals prematurely recognized revenue from this sale. Moreover, before the shipper took possession of these goods, the customer informed Serologicals that it would not accept them until Serologicals resolved certain quality assurance issues.
SEROLOGICALS IMPROPERLY UNDERSTATED VARIOUS EXPENSES
G. During the first, second and third quarters of 1999, Serologicals understated its cost of goods sold because it failed to accurately reconcile its plasma inventory on hand with the plasma inventory reported on its books; Serologicals had less actual inventory on hand than it recorded. Consequently, Serologicals overstated its net income by $343,000 and $38,000 in the first and second quarters of 1999, respectively, and understated its net loss by $107,000 in the third quarter of 1999.
H. In addition, Serologicals failed to accurately record depreciation expenses during 1999 because it did not reclassify certain assets as permanent after completing construction of those assets. Serologicals also failed to record expenses for contributions to Serologicals Proteins' pension fund during the first quarter of 1999; instead they incorrectly accounted for those contributions as part of the purchase price for Pentex. Combined, these understated expenses caused Serologicals to overstate net income by $131,000 and $62,000 in the first and second quarters of 1999, respectively, and understate its net loss by $61,000 in the third quarter of 1999.
SEROLOGICALS LACKED SUFFICIENT INTERNAL ACCOUNTING CONTROLS
I. During 1999, Serologicals failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that (1) its financial statements were prepared in conformity with GAAP and (2) transactions were executed in accordance with management's general or specific authorization.
J. Serologicals lacked procedures to reveal Serologicals Proteins' improper recognition of revenue from bill-and-hold sales. For example, in January 1999, Serologicals Proteins issued two credit memos to reverse certain sales that represented approximately seventeen percent of Serologicals Proteins' outstanding accounts receivable as of December 31, 1998. Each memo stated that the customer rejected the product before it was shipped, clearly indicating that Serologicals Proteins had improperly recognized revenue prior to shipment. Serologicals, however, had no policy at the time that required such credit memos to be sent to Serologicals' accounting department. Such a policy would have alerted Serologicals to Serologicals Proteins' improper revenue recognition practice, notwithstanding the seller's representation, made in connection with the sale of Pentex, that Pentex's financial statements were prepared in accordance with GAAP.
K. In June 1999, Serologicals distributed a new policy that required certain conditions be met before the company would permit bill-and-hold transactions. Although the accounting personnel at Serologicals Proteins received this policy, they made no effort to implement it and Serologicals took no steps to determine whether Serologicals Proteins was in compliance with the policy, which it was not.
L. Serologicals also lacked procedures in 1999 to ensure that it accurately reconciled the plasma inventory on hand with the plasma inventory reported on its books. Serologicals discovered a discrepancy between these amounts during its 1998 year end inventory count and corrected its financial statements prior to filing its 1998 Form 10-K. Because Serologicals' outside auditors viewed the discrepancy as significant, they recommended in early 1999 that Serologicals re-evaluate its inventory reconciliation procedures to prevent this problem from reoccurring. Despite this recommendation, Serologicals made no changes to its inventory reconciliation procedures during 1999, and due to problems with its vendor did not timely implement in 1999 as planned a new computer system designed in part to improve inventory tracking. Because Serologicals failed to improve its inventory reconciliation procedures during 1999, at the end of that year Serologicals again discovered a discrepancy between the plasma inventory on hand and the plasma inventory reported on its books.
SEROLOGICALS' INACCURATE FILINGS WITH THE COMMISSION AND LATER RESTATEMENTS
M. On May 12, 1999, Serologicals filed its Form 10-Q for the first quarter of 1999 with the Commission. Therein, Serologicals inaccurately reported net income of $4.55 million for the quarter. Serologicals' actual net income during the first quarter was $4.08 million, or 11.2 percent less than the amount initially reported. The material overstatement of net income resulted from (a) improper inventory reconciliation, causing costs of goods sold to be understated and (b) the failure to record depreciation and pension expenses.
N. On August 11, 1999, Serologicals filed its Form 10-Q for the second quarter of 1999 with the Commission. Therein, Serologicals inaccurately reported net income of $2.81 million for the quarter. Serologicals' actual net income during the second quarter was $2.39 million, or 17.4 percent less than the amount initially reported. The material overstatement of net income resulted from (a) improper recognition of revenue from bill-and-hold sales, (b) improper inventory reconciliation, and (c) the failure to record depreciation expenses.
O. On November 12, 1999 Serologicals filed its Form 10-Q for the third quarter of 1999 with the Commission. Therein, Serologicals inaccurately reported a net loss of $5.99 million for the quarter. Serologicals' actual net loss during the third quarter was $6.78 million, or 11.6 percent more than the loss initially reported. The material understatement of Serologicals' net loss resulted from (a) improper recognition of revenue from bill-and-hold sales, (b) improper recognition of revenue from a sale where title had not passed to the customer, (c) improper inventory reconciliation, and (d) the failure to record depreciation expenses.
P. On April 10, 2000, Serologicals publicly released its 1999 year-end financial results together with the restated results for the first three quarters of 1999. The restatements corrected the revenue from the improper bill-and-hold sales, the improper recognition of the sale during the third quarter of 1999, and the understated cost of goods sold, depreciation and pension expenses. The restatement materially reduced the Company's net income for the first and second quarters of 1999 and materially increased the net loss reported for the third quarter of 1999.
VIOLATIONS OF THE FEDERAL SECURITIES LAWS
Q. Section 13(a) of the Exchange Act and Rule 13a-13 thereunder require issuers of registered securities to file with the Commission quarterly reports prepared in conformity with the requirements of the Commission's rules and regulations. Courts have held that it is implicit in this requirement that the information provided be accurate and contain no material misrepresentations or omissions. See, e.g., SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). In addition, Exchange Act Rule 12b-20 requires that these periodic reports contain all information necessary to ensure that the statements made in them are not materially misleading. No showing of scienter is necessary to establish a violation of Section 13(a) or Rules 12b-20 and 13a-13. Savoy Industries, 587 F.2d at 1167; Tenex Corp., Exchange Act Rel. No. 41312 (April 20, 1999), 69 SEC Docket 1814, 1834 n. 11. A violation occurs when a materially false statement is filed. SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975).
R. Section 13(b)(2)(A) of the Exchange Act requires issuers of securities to make and keep books, records and accounts which accurately and fairly reflect their transactions and the dispositions of their assets. Exchange Act Rule 13b2-1 prohibits any person from, directly or indirectly, falsifying or causing to be falsified any book, record or account subject to Section 13(b)(2)(A). No showing of scienter is necessary to establish a violation of Section 13(b)(2)(A) or Rule 13b2-1. SEC v. World Wide Coin Investments, Ltd., 567 F. Supp. 724, 749 (N.D.Ga.1983); Joseph E. Williams, Exchange Act Rel. No. 42412 (Feb. 10, 2000), 71 S.E.C. Docket 1770, 1776.
S. Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that, among other things, transactions are executed in accordance with management's authorization and that transactions are recorded as necessary to permit the preparation of financial statements in conformity with GAAP and to maintain accountability for assets. No showing of scienter is necessary to show a violation of Section 13(b)(2)(B). SEC v. World Wide Coin Investments, Ltd., 567 F. Supp. at 751.
T. By the acts and omissions alleged in paragraphs III.B through III.P, Serologicals violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-13 and 13b2-1 thereunder. Serologicals violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 by filing Forms 10-Q for the first, second and third quarters of 1999 which contained materially misleading information regarding its financial performance. Serologicals violated Section 13(b)(2)(A) of the Exchange Act by failing to keep books, records, and accounts that accurately recorded its transactions and assets for the first, second and third quarters of 1999. Serologicals also violated Rule 13b2-1 by falsely recording transactions and revenue in its books, records and accounts during 1999. Finally, Serologicals violated Section 13(b)(2)(B) of the Exchange Act by failing to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that its transactions were (1) executed in accordance with management's authorization and (2) recorded as necessary to permit the preparation of financial statements in conformity with GAAP.
In view of the foregoing, the Commission deems it appropriate to accept Serologicals' Offer of Settlement. In determining to accept the Offer, the Commission considered the cooperation Serologicals afforded the Commission staff.
ACCORDINGLY, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act that Serologicals 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-13, and 13b2-1 thereunder.
By the Commission.
Jonathan G. Katz
1 The findings herein are made pursuant to Serologicals' Offer of Settlement and are not binding on any other person or entity named in this or any other proceeding.
2 A bill-and-hold transaction is generally a practice whereby a customer agrees to purchase goods but the seller retains physical possession until the customer requests shipment to designated locations. There are very limited circumstances under Generally Accepted Accounting Principles ("GAAP") that permit a seller to recognize revenue from a bill-and-hold transaction prior to shipping the goods, none of which were applicable in this instance.
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