SECURITIES EXCHANGE ACT OF 1934
Release No. 48485 / September 11, 2003
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 1861 / September 11, 2003
ADMINISTRATIVE PROCEEDING
File No. 3-11257
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ORDER INSTITUTING PROCEEDINGS PURSUANT TO SECTION 21C OF THESECURITIES EXCHANGE ACT OF 1934,MAKING FINDINGS AND IMPOSING A CEASE-AND-DESIST ORDER |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Stephen D. Price ("Price" or "Respondent").
II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purposes 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 jurisdiction over him and the subject matter of these proceedings, which are admitted, Respondent consents to the entry of this Order Instituting Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order ("Order").
III.
FACTS
On the basis of this Order and the Respondent's Offer, the Commission finds that:
A. Respondent
Stephen D. Price, age 31, resides in Bronxville, New York. Between 1999 and 2001, Price was the Vice President of Business Development for CAIS Internet, Inc. ("CAIS"), an Internet networking company. In that capacity, Price worked closely with CAIS's senior management to identify possible acquisition candidates and strategic business partners. Price also worked with CAIS's salespeople to assist in software, services, and product sales.
B. Relevant Entities
CAIS was, during the relevant time, a Delaware corporation with its principal place of business in Washington, D.C. CAIS's securities were registered with the Commission pursuant to Section 12(g) of the Exchange Act. After its initial public offering in May 1999, CAIS's stock traded on the Nasdaq National Market under the ticker symbol CAIS. In 2000, CAIS's stock reached a high of approximately $43 per share. In 2001, the company filed for bankruptcy protection, and is now known as Ardent Communications, Inc. Ardent's securities are quoted on the pink sheets under the symbol ARDTQ, and trade at less than a penny per share.
Logic Solutions, Inc. ("Logic") is a privately-held software consulting company whose principal offices are located in Ann Arbor, Michigan.
C. Summary
This matter involves improper conduct by Price in causing CAIS to materially overstate its financial results for the third quarter ended September 30, 2000. On September 29, 2000, Price arranged a $1,012,500 sale of merchandise to Logic, which accounted for about 9% of CAIS's reported revenue for the quarter. In connection with this sale, Price entered into an oral side agreement with Logic, which allowed it to return the merchandise if CAIS did not make an investment in Logic within 60 days. Price knew that Logic could not pay for the merchandise without the investment from CAIS.
In December 2000, Logic returned the merchandise after CAIS decided not to invest. Because of Logic's right of return, CAIS should not have recorded the revenue in the third quarter ended September 30, 2000 under Generally Accepted Accounting Principles. Price's failure to inform CAIS's senior management and internal accountants about the side agreement caused CAIS to materially overstate its financial results and file a false and misleading Form 10-Q with the Commission. As a result, Price violated Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and was a cause of CAIS's violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
D. The Contingent Sale to Logic Solutions
In 2000, CAIS was a provider of high-speed Internet network services and a manufacturer of stand-alone Internet computer kiosks and software. CAIS operated two wholly-owned subsidiaries, CAIS Software Solutions Inc., and Business Anywhere USA Inc. CAIS Software, based in San Diego, developed software and other computer products that were incorporated into the Internet kiosks.
In early 2000, Price met the President of Logic, who at the time was seeking a venture capital investor. By September 2000, Price began discussing possible business ventures between CAIS and Logic. On or about September 22, 2000, Price received an e-mail from Logic requesting that CAIS invest $3.5 million in the company. The e-mail also suggested that, if CAIS made the investment, Logic would purchase $1.5 million worth of Internet kiosks from CAIS. Specifically, the e-mail stated: "If you can commit to the funding to Logic that we have discussed we can commit to purchase and transfer your kiosks."
Within a week, Price visited Logic's office in Michigan to discuss the proposal. While there, Price agreed to arrange a $3-4 million investment if Logic purchased $1 million of CAIS Internet kiosks. Price also agreed that Logic could use the money from CAIS's investment to pay for the kiosks.
On September 29, Logic's Chief Financial Officer signed a purchase order to buy 110 CAIS Internet kiosk units for $1,012,500. Although CAIS normally required customers to pay for merchandise within 30 days, Price amended the purchase order to allow Logic 60 days to pay for the equipment, knowing that Logic would not have the money to pay for the kiosks until the proposed investment was finalized. Price believed that 60 days would be enough time to close the transaction and supply Logic with the money to pay CAIS. On the same day, CAIS shipped the equipment and recorded the $1,012,500 sale. When Logic submitted the purchase order, Price knew that Logic would not pay for the kiosks without the proposed investment from CAIS. The purchase order and the associated documents, however, did not refer to any investment by CAIS, nor to Logic's right to return the equipment in the event that CAIS failed to provide funding.
During October 2000, before CAIS filed its Form 10-Q with the Commission, CAIS's CFO heard a rumor that Logic did not intend to pay CAIS for the kiosk equipment. The CFO questioned Price about the rumor, and Price told him that Logic would pay for the equipment under the terms set forth in the purchase order. Price failed to tell the CFO that Logic could not pay for the kiosks without CAIS's investment and would return the merchandise if the investment did not occur. Moreover, Price specifically told the CFO that there were no contingencies preventing CAIS from recording the sale in the third quarter.
At the end of October, the President of Logic sent an e-mail to Price asking about the status of CAIS's proposed investment in Logic. Logic's President emphasized the need for the investment and proposed that CAIS acquire ten percent of Logic. Regarding the kiosk purchase, he wrote:
The other thing that I want to clarify is that our [agreement to purchase] the Kiosks hinges on the investment itself. . . . Only if the investment actually happens, [does it] make sense for us to take [possession of the Kiosks]. If there is no agreement in sight any time soon, we have to talk about how to [return] those Kiosks back to you.
The following day, Price responded: "I received your e-mail. I will try to call you by the end of the week to discuss." In a subsequent phone call, Price told Logic's President that he believed CAIS would make the investment, but it would take some more time to complete the deal.
On November 6, CAIS issued a press release announcing its results for the third quarter ended September 30, 2000. CAIS reported total net revenues of $11,082,000. The reported results included $1,012,500 of revenue from the sale to Logic, which accounted for approximately 9% of CAIS's revenue for the quarter.
On November 14, 2000, Price traveled to Michigan and met with Logic's President and others to negotiate the terms of CAIS's possible investment. At the meeting, Price and Logic's President again confirmed that if CAIS did not invest in Logic, Logic could return the kiosks without paying for the equipment.1 On that same day, CAIS filed a Form 10-Q with the Commission for the quarter ended September 30, 2000. CAIS included the Logic sale in its reported numbers, increasing its revenue and accounts receivable by $1,012,500.
Later in November, senior management of CAIS informed Price that the company did not have enough cash to make an investment in Logic. On December 5, after learning that CAIS would not make an investment, Logic's CFO sent Price a notice canceling the purchase order and terminating the September 29 kiosk purchase. In the notice, Logic's CFO asked CAIS to confirm that "other than returning the equipment [Logic] will have no further obligation under the Agreement or the Order Form attached thereto." Price signed the letter agreement on behalf of CAIS, and permitted Logic to return the equipment.2
In connection with the sale to Logic, CAIS's recognition of revenue was in contravention of Generally Accepted Accounting Principles. Specifically, Statement of Financial Accounting Standards No. 48, Revenue Recognition Where Right of Return Exists, precludes revenue recognition on sales to resellers where the buyer is not obligated to pay the seller or where the buyer lacks the financial ability to pay apart from financing provided by the seller. Here, Price's promised investment and acknowledgement that Logic could return the equipment if the funding did not materialize prohibited CAIS from recognizing the revenue from the Logic sale in the third quarter ended September 30, 2000. Thus, CAIS overstated its revenue and filed a materially false and misleading Form 10-Q with the Commission.
IV.
LEGAL ANALYSIS
A. Price Violated Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraudulent conduct in connection with the purchase or sale of securities. Violations of Section 10(b) and Rule 10b-5 occur when an issuer makes material misstatements or omits material information in periodic reports filed with the Commission, including financial statements, and trading thereafter occurs in the issuer's securities. SEC v. Texas Gulf Sulphur, 401 F.2d 833, 860-862 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969); SEC v. Great American Indus., 407 F.2d 453 (2d Cir.), cert. denied, 395 U.S. 920 (1968). A fact is material if there is a "substantial likelihood that the . . . fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976). Information regarding the financial condition of a company is presumptively material. SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985). Evidence of scienter - an intent to deceive or defraud - is required to establish a violation of Section 10(b) and Rule 10b-5. Aaron v. SEC, 446 U.S. 680, 691 (1980). That showing can be satisfied by evidence of reckless behavior by the person charged. Rolf v. Blyth Eastman Dillon & Co., 570 F.2d 38, 44 (2d Cir. 1978), cert. denied, 439 U.S. 1039 (1978).
As a result of the conduct described above, Price violated these antifraud provisions because he knew that CAIS would record $1,012,500 from the sale to Logic as revenue in the third quarter even though he entered an oral side agreement allowing Logic to return the equipment if CAIS did not make the investment. Price concealed the side agreement from senior management at the company as well as its internal accountants. As a result of Price's knowing conduct, CAIS overstated its revenue, accounts receivable and net income for the third quarter ended September 30, 2000 and filed a materially false and misleading Form 10-Q with the Commission.
B. Price Was a Cause of CAIS's Violations of the Reporting and Recordkeeping Provisions of the Exchange Act
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. 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. In addition, Rule 12b-20 of the Exchange Act requires that these periodic reports contain all information necessary to ensure that the statements made in them are not materially misleading. A violation occurs when a materially false statement is filed. SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975). Because CAIS incorrectly recorded the revenue from the Logic sale and filed materially false and misleading financial statements in its third quarter 2000 Form 10-Q, it violated Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
Section 21C of the Exchange Act provides that the Commission may order any person who is or was a cause of a violation of any provision of the Exchange Act, due to an act or omission the person knew or should have known would contribute to the violation, to cease and desist from committing or causing such violations. Price, by concealing the existence of the oral side agreement he negotiated with Logic, caused CAIS to file false and materially misleading financial statements with the Commission and to violate the reporting and recordkeeping provisions of the Exchange Act.
C. Price Violated Section 13(b)(5) of the Exchange Act and Exchange Act Rules 13b2-1 and 13b2-2
Section 13(b)(5) of the Exchange Act prohibits knowingly falsifying an issuer's books, records, or accounts or circumventing its internal controls. Rule 13b2-1 of the Exchange Act 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). Rule 13b2-2 of the Exchange Act prohibits directors and officers from, directly or indirectly, making or causing materially false or misleading statements to an accountant in connection with an audit or the preparation of Commission filings. Due to Price's concealment of the contingent nature of the Logic sale from CAIS's senior management and internal accountants, CAIS's books and records did not properly account for the contingent nature of the sale. As a result, Price violated Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 thereunder.
V.
FINDINGS
Based on the foregoing, the Commission finds that Price violated Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and was a cause of CAIS's violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
VI.
ORDER
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Respondent Stephen D. Price cease and desist from committing or causing any violations and any future violations of Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and from causing any violations and any future violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
By the Commission.
Jonathan G. Katz
Secretary
1 This conversation was memorialized in a November 20 e-mail from Logic's President to Price: "There is no [illusion] that if somehow this investment does not happen, we will return all the equipment[ ] that we have received." Price responded: "I got your e-mail. I am fine with it."
2 Because CAIS reversed the sale on its books in the fourth quarter of 2000, its year-end financial results were correct. CAIS, however, did not restate its third quarter results.