UNITED STATES OF AMERICA
SECURITIES AND EXCHANGE COMMISSION
Securities Exchange Act of 1934
Release No. 46909 / November 26, 2002
Accounting and Auditing Enforcement
Release No. 1677 / November 26 2002
File No. 3-10954
In the Matter of
| ORDER INSTITUTING |
MAKING FINDINGS, AND IMPOSING
A CEASE-AND-DESIST ORDER
PURSUANT TO SECTION 21C OF THE
SECURITIES EXCHANGE ACT OF 1934
The Securities and Exchange Commission ("Commission") deems it appropriate that public cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against First Virtual Communications, Inc. ("FVC" or "Respondent").
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "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 herein, except as to the Commission's jurisdiction over it and the subject matter of these proceedings, and the findings contained in Section III.1. below, which are admitted, Respondent consents to the entry of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds that:
- FVC is a Delaware corporation with its headquarters in Santa Clara, California. FVC's common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and currently trades on Nasdaq's Small Cap Market. Since 1993, FVC has engineered and manufactured video-conferencing products and has worked closely with distributors to market and sell these products to the ultimate customer.
- In the fourth quarter of fiscal 1998, in order to convince its largest distributor (the "Distributor") to purchase $3 million of FVC product before the end of the year, FVC granted the Distributor various return rights. Specifically, FVC granted exchange rights on the $3 million of product to be purchased by year end 1998, return rights on $2.5 million of FVC product that the Distributor had previously purchased from FVC and received back from its own customer, and rotation rights on $1.9 million of excess inventory that FVC had previously sold to the Distributor and that remained in the Distributor's warehouse.
- The exchange rights allowed the Distributor to return the product in exchange for another product of the same or greater value that was better suited to the end users' needs. The return rights allowed the Distributor to return the product in exchange for a credit against the balance owed. The rotation rights required FVC to work with the Distributor to ensure that the product "was good and saleable." FVC did not expressly limit the exchange and rotation rights to product of the same kind, quality, and price. These exchange, return, and rotation rights are collectively referred to as "Return Rights."
- Based on FVC's agreement to the Return Rights, the Distributor issued purchase orders totaling $3 million to FVC on December 29, 1998. FVC shipped $1.5 million of product before the end of December 1998 which FVC recognized as revenue in 1998.
- For FVC to recognize revenue at the time of sale when the Distributor has return rights, Statement of Financial Accounting Standards No. 48 requires, among other things, that FVC must be reasonably able to estimate the amount of future returns. FVC had no reasonable basis for estimating the amount of future returns from the Distributor, because FVC had previously never granted such Return Rights to the Distributor and had granted return rights to only one small customer. Moreover, FVC's ability to estimate returns was further impaired by the facts that its products were subject to technological obsolescence and changing demand and it had granted the Distributor a relatively long period, up to six months, to return the product.
- FVC recorded, and announced in a January 28, 1999 press release, revenue of $12.3 million for the fourth quarter 1998 and $44.4 million for fiscal 1998. These amounts included the $5.9 million in revenue from the $1.5 million sale with exchange rights, the $2.5 million sale with return rights, and the $1.9 million sale with rotation rights.1 Based on this revenue, FVC recognized and announced earnings of $1.2 million for fourth quarter 1998 and $1.1 million for fiscal 1998 (excluding interest, miscellaneous income, and a one time charge relating to an acquisition). FVC's stock price increased 37.5% in the two days after issuance of the press release, while trading volume increased by over 500% from average January 1999 trading volume before the January 28 announcement.
- Because FVC had granted the Distributor the Return Rights on the $5.9 million in sales and could not reasonably estimate returns, FVC could not under Generally Accepted Accounting Principles recognize the revenue from these sales. As a result of improperly recognizing this revenue, FVC overstated its fourth quarter 1998 revenue by 114% and fiscal 1998 revenue by 16%. Similarly, without the improperly recognized revenue (and associated cost of goods sold), FVC would have recognized a loss of $1.9 million for fourth quarter 1998 and a loss of $2 million for fiscal 1998.
- In the first quarter of 1999, FVC authorized four returns from the Distributor totaling over $2.6 million of product. FVC received two of these returns totaling $1.6 million of product in the first quarter 1999, and the remaining two returns totaling $1.029 million of product in the second quarter 1999. FVC accounted for these returns by subtracting the value of the return from the balance the Distributor owed FVC.
- On March 29, 1999, FVC informed its auditors of the Return Rights it had granted the Distributor. Shortly thereafter, based on the auditors' advice, FVC reversed the revenue from the $5.9 million in sales with the Return Rights.
- As a result of this $5.9 million adjustment and an additional $1.2 million in other revenue reversals, FVC revised its fourth quarter 1998 revenue from $12.3 million to $5.2 million and its fiscal 1998 revenue from $44.4 million to $37.3 million. FVC also revised its fourth quarter 1998 earnings from a $1.2 million profit to a $3.21 million loss and its fiscal 1998 earnings from a $1.1 million profit to a $3.31 million loss. FVC announced these revised revenue and earnings figures in an April 6, 1999 press release and its December 31, 1998 Form 10-K filed on April 15, 1999.
- On April 7, 1999, the day after the revised revenue and earnings figures were released, FVC's share price fell 60% with a large increase in trading volume.
- As a result of the conduct described above, FVC violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit misstatements or omissions of material fact in connection with the purchase or sale of a security. FVC committed fraud by issuing the January 28, 1999 press release that materially overstated revenues and earnings figures for fourth quarter and fiscal 1998.2
- Further, as a result of the conduct described above, FVC violated Section 13(b)(2)(A) of the Exchange Act, which requires that every issuer of securities pursuant to Section 12 of the Exchange Act make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the issuer's transactions and disposition of assets. As discussed above, FVC failed to keep accurate records of product sales and various return rights granted on product sold to FVC's largest distributor.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Respondent's Offer.
ACCORDINGLY, IT IS ORDERED that:
Pursuant to Section 21C of the Exchange Act, Respondent cease and desist from committing or causing any violations and any future violations of Sections 10(b) and 13(b)(2)(A) of the Exchange Act and Rule 10b-5 thereunder.
By the Commission.
Jonathan G. Katz
||FVC booked the $1.5 million sale in Q4 1998. For the purposes of the April 1999 revision, FVC also treated the $2.5 million and $1.9 million sales as having been recognized in Q4 1998.|
||The Commission has simultaneously reached an injunctive settlement with the three officers responsible for FVC's violations.|