UNITED STATES OF AMERICA
In the Matter of
Oxford Health Plans, Inc.,
Andrew B. Cassidy,
and Brendan R. Shanahan,
|ORDER INSTITUTING PUBLIC PROCEEDINGS PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934 AND IMPOSING A CEASE-AND-DESIST ORDER|
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted against Oxford Health Plans, Inc. ("Oxford"), Andrew B. Cassidy ("Cassidy"), and Brendan R. Shanahan ("Shanahan") (collectively, the "Respondents"), pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act").
In anticipation of the institution of these administrative proceedings, the Respondents have submitted Offers of Settlement (the "Offers"), 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 findings contained herein, except as to the Commission's finding of jurisdiction over the Respondents and the subject matter of this proceeding, which the Respondents admit, the Respondents consent to the issuance of this Order Instituting Public Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934 and Imposing a Cease-And-Desist Order ("Order") and to the entry of the findings and imposition of relief set forth below.
On the basis of this Order and the Offers submitted by the Respondents, the Commission finds that:
A. Oxford is a Delaware corporation with principal offices located in Trumbull, Connecticut. Oxford is a provider of health benefit plans, including point-of-service plans, health maintenance organizations, and Medicare programs. Oxford's common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act. Oxford's stock, which traded on the NASDAQ during the relevant period, is listed on the New York Stock Exchange. Oxford is an "issuer" for purposes of the Exchange Act.
B. Cassidy at all relevant times was the Chief Financial Officer ("CFO") of Oxford.
C. Shanahan at all relevant times was the controller and vice president of finance of Oxford. Shanahan is a CPA licensed in the State of New York.
Oxford Erroneously Recorded $81 Million of Revenue On Its Books and Records Because Its System of Internal Accounting Controls Failed To Prevent the Error
D. For the months of January 1997 through September 1997, Oxford erroneously recorded on its internal books and records an aggregate of $81 million of revenue that it should not have recorded. This occurred because Oxford incorrectly recorded into the current revenue account certain items from the deferred and unearned revenue accounts. Oxford recorded revenue based on revenue reports that incorrectly included unearned revenue in the report's computation of deferred revenue.1 As a result, Oxford failed to perform appropriate reversing entries when reclassifying the deferred and unearned revenues into current revenue. Therefore, for the months January through September 1997, Oxford erroneously counted the prior month's unearned revenue as current revenue twice, when such unearned revenue should have been counted once. On a quarterly basis, this error caused Oxford's revenues to be overstated on its internal books and records as follows:
|First Quarter 1997||$3 million|
|Second Quarter 1997||$25 million|
|Third Quarter 1997 (through September 97)||$53 million2|
E. Oxford discovered the erroneously recorded revenues during the preparation of its third quarter 1997 financial reports. Oxford's system of internal accounting controls did not detect or prevent the company from erroneously recording the $81 million of revenues on its internal books and records. As a result, for the months of January through September 1997, Oxford's system of internal accounting controls failed reasonably to ensure that revenues were booked correctly.
Oxford Failed to Restate Net Income That It Had Materially
Overstated In Its Form 10-Q for the Period Ended June 30, 1997,
and Oxford Did Not Specifically Disclose That It Had Erroneously
Recorded $81 Million of Revenues On Its Books and Records
F. On August 5, 1997, Oxford filed with the Commission on Form 10-Q Oxford's unaudited financial statements for the period ended June 30, 1997 (the second quarter). Oxford reported that its net income for that quarter was $37 million.
G. Oxford planned to file with the Commission in early November 1997 a Form 10-Q reporting its unaudited financial statements for the period ended September 30, 1997. Shortly before October 27, 1997, Oxford determined that certain problems had materially affected and would affect Oxford's financial condition. These problems included that Oxford erroneously had recorded on its internal books and records $81 million in revenue for the months of January through September 1997, including revenue reported in the second quarter financial statements contained in Oxford's June 30, 1997 Form 10-Q.
H. On October 27, 1997, Oxford filed with the Commission a Form 8-K that contained information concerning Oxford's results of operations. Oxford stated that its revenues were expected to be $111 million lower than previous estimates due to adjustments to membership resulting from delayed premium bills. Oxford also announced a charge to net earnings of between $47 million and $53 million for additions to reserves for medical claims. According to Oxford, these two elements would result in an expected loss of between $.83 and $.88 per share for the third quarter of 1997 (at a time when consensus analysts' estimates had predicted a profit of about $.48 per share). Oxford's Form 8-K did not specifically disclose that $81 million of the announced $111 million revenue shortfall from previous revenue estimates was attributable to revenues that Oxford had erroneously recorded.
I. On November 13, 1997, Oxford filed with the Commission on Form 10-Q Oxford's unaudited financial statements for the period ended September 30, 1997 (the third quarter). Oxford reported a net loss of $78 million or $.99 per share for the quarter, and described various charges reported in the financial statements.
J. The $81 million of revenue erroneously recorded on Oxford's internal books and records included $25 million attributable to the second quarter of 1997. As a result, Oxford's net income as reported in the June 30, 1997 Form 10-Q was overstated by 26%. Based on an analysis conducted in late October 1997, after the error was discovered, Oxford erroneously concluded that net income was overstated by 12.9%. Oxford's analysis aggregated or "netted" certain favorable revenue and unfavorable expense events not previously reported in the second quarter financial statements against the overstated revenues, which events minimized the impact of the revenue overstatement on net income. The principal event used in the analysis was a gain contingency related to the outcome of a lawsuit concerning a refund Oxford believed it was due for amounts paid into an allegedly overfunded malpractice insurance pool. The inclusion of this event in the second quarter was inconsistent with Generally Accepted Accounting Principles ("GAAP"), and therefore any amount related to this gain contingency should not have been considered in the restatement analysis.
K. Oxford considered whether it should restate its second quarter financial statements and concluded that no restatement was required because the overstatement of net income (which Oxford calculated as 12.9%) was not material under the circumstances. In fact, the overstatement was 26% of net income, which was material. Even if Oxford's computation of a 12.9% overstatement had been correct, that amount would also have been material.
L. Because Oxford reported a material overstatement of net income for the second quarter of 1997, Oxford should have restated its financial statements, including net income, for that quarter. Oxford, however, failed to restate its financial statements for the second quarter of 1997.
Cassidy and Shanahan's Involvement With Oxford's Erroneous Recording of Revenue and Oxford's Failure to Restate
M. Cassidy, Oxford's CFO, shared responsibility for devising and implementing adequate internal controls, and he indirectly supervised the department that employed the people who erroneously recorded the $81 million in revenue on Oxford's books and records. Cassidy failed to take sufficient steps reasonably designed to prevent this error.
N. Cassidy signed the Form 8-K that contained the October 27th announcement and the third quarter 1997 Form 10-Q. Cassidy did not prepare or participate in the preparation of the analysis described in paragraph J above, which formed the basis for Oxford's erroneous decision not to restate. That analysis and all other underlying facts were, however, available to him.
O. Shanahan, Oxford's controller, had some responsibility for devising and implementing adequate internal accounting controls, and he supervised the department that employed the people who were directly responsible for erroneously recording the $81 million in revenue. Shanahan failed to take sufficient steps reasonably designed to prevent this error.
P. Shanahan contributed to Oxford's incorrect determination not to restate its financial statements for the second quarter of 1997. Before Oxford filed the September 30, 1997 Form 10-Q, Shanahan conducted the analysis described in paragraph J above, which formed the basis for Oxford's erroneous decision not to restate. Shanahan told Oxford's management that he believed that restatement would not be necessary because the overstatement of net income was not material under the circumstances, when in fact the overstatement was material. Shanahan consulted with Oxford's outside auditor in forming his opinion that no restatement was required, and he reported to Cassidy concerning that consultation.
The Commission's Investigation
Q. During the Commission's investigation of the matters discussed in this Order, Oxford produced documents and made witnesses available for testimony in response to Commission subpoenas, as is required by law. Oxford's cooperation did not extend beyond its legal obligations.3
Oxford Violated Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 Thereunder
R. Section 13(a) of the Exchange Act and Rules 13a-11 and 13a-13 thereunder require issuers to file certain reports, including quarterly reports, with the Commission. The requirement that an issuer file reports under these provisions embodies the requirement that such reports be true and correct. SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975); SEC v. IMC International, Inc., 384 F. Supp. 899, 893 (N.D. Texas), aff'd, 505 F.2d 733 (5th Cir. 1974). 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. Section 13(b)(2)(A) of the Exchange Act 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.
S. The filing of financial statements not prepared in conformity with GAAP violates Section 13(a) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 thereunder because Regulation S-X specifically provides that financial statements not prepared in conformity with GAAP are presumed to be misleading or inaccurate.
17 C.F.R. 210.4-01(a)(1). Similarly, the recording of revenues in violation of GAAP violates Section 13(b)(2)(A) of the Exchange Act. Oxford's reported and recorded second quarter 1997 financial statements violated GAAP because those statements erroneously included revenues that were not earned. See Statement of Financial Concepts No. 5, par. 83 (revenues are not to be recognized until earned).
T. Because Oxford erroneously recorded $25 million of unearned revenues during the second quarter of 1997, Oxford's reported second-quarter revenues were overstated by that amount, and its reported net income was thereby overstated by 26%. Quantitatively, that amount was material. See SAB 99, 64 Fed. Reg. 45150 (1999) (use of a percentage as a numerical threshold as an initial step in assessing materiality is permissible). Even if the overstatement had been only 12.9%, as Oxford erroneously concluded at the time, that amount was also quantitatively material. See id. Furthermore, a declining earnings trend that had been developing since the second quarter of 1997 was not reflected in Oxford's public disclosures because of the erroneously recorded revenues. See Ganino v. Citizens Utilities Co., 228 F.3d 154, 163 (2d Cir. 2000) (important qualitative factor to consider in determining whether a numerical misstatement is material is "`whether the misstatement masks a change in earnings or other trends'") (quoting SAB 99, 64 Fed. Reg. at 45152); In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1421 n.9 (3d Cir. 1997) (information about current and past earnings is highly likely to be material because it is often used to predict what future earnings might be); In re Kidder Peabody Sec. Litig., 10 F. Supp. 2d 398, 410 (S.D.N.Y. 1998) (same). Because the amount of overstated net income was material, Oxford was obligated to restate publicly its financial statements for the second quarter of 1997.
U. Oxford's third quarter 1997 financial statements, as reported in its Form 10-Q for this period, violated GAAP by failing to include a restatement of the second quarter and by failing to disclose specifically the existence and cause of the erroneously recorded revenues in the note discussing the third quarter 1997 charges. APB Opinion 20, paragraph 37 ("The nature of an error in previously issued financial statements and the effect of its correction on income before extraordinary items, net income, and the related per share amounts should be disclosed in the period in which the error was discovered and corrected.").
V. As a result, Oxford's financial statements for the second and third quarters of 1997 were inaccurate, in violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 thereunder.
W. 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 transactions are booked accurately, in accordance with management directives, and in a manner designed to permit the preparation of financial statements in conformity with GAAP.
X. Oxford's system of internal accounting controls was inadequate for the purposes of Section 13(b)(2)(B) of the Exchange Act from January through September 1997, as demonstrated by Oxford's erroneous recording on its internal books and records during that period of $81 million of revenue and its resulting material overstatement of reported net income for the second quarter. As a result, Oxford violated Section 13(b)(2)(B) of the Exchange Act.
Cassidy and Shanahan Were Both Causes of Oxford's Violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 Thereunder
Y. Cassidy contributed to Oxford's violations by failing to ensure that Oxford had internal controls that were sufficient to prevent the erroneous recording of revenue and by signing Oxford's October 27, 1997 Form 8-K and third quarter 1997 Form 10-Q. By reason of the conduct and events set forth above, Cassidy was a cause of Oxford's violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 thereunder.
Z. Shanahan's failure to ensure that Oxford had internal controls that were sufficient to prevent the erroneous recording of revenue and his statement to Oxford's management that the second quarter 1997 overstatement of net income did not compel restatement contributed to Oxford's violations. By reason of the conduct and events set forth above, Shanahan was a cause of Oxford's violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 thereunder.
Accordingly, IT IS HEREBY ORDERED that:
A. Oxford shall cease and desist from committing or causing any violation, or committing or causing any future violation, of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 thereunder.
B. Cassidy and Shanahan shall cease and desist from causing any violation or any future violation of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-11, and 13a-13 thereunder.
By the Commission.
Jonathan G. Katz
|1||Deferred revenue represents premium billings made in advance of the coverage month. Unearned revenue, which is a liability account, represents premium billings made and paid in advance of the coverage month. Because these "future" revenues were billed and in some cases paid prior to the relevant coverage period, Oxford properly recorded them as liabilities. When the coverage was provided, the income was then considered to be earned, at which point Oxford properly moved the deferred and unearned revenue into the current revenue account.|
|2||This $53 million amount was not reported in any Commission filing.|
|3||The Commission is today also filing a complaint in U.S. District Court for the Southern District of New York against Oxford to obtain civil money penalties of $250,000 from Oxford based upon Oxford's conduct as described in this Order. Cassidy and Shanahan are not named in this complaint.|
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