SECURITIES EXCHANGE ACT OF 1934
Release No. 50098 / July 27, 2004
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 2064 / July 27, 2004
Admin. Proc. File No. 3-11563
In the Matter of Charter Communications, Inc. Respondent. |
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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 |
I.
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 Charter Communications, Inc. ("Charter" or "Respondent").
II.
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, 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.
III.
On the basis of this Order and Respondent's Offer, the Commission finds that:
Respondent
1. Charter is a Delaware Corporation with its principal executive office located in St. Louis, Missouri. Charter is the third largest cable television operator in the United States serving approximately 6.2 million customers in 37 states. Through its subsidiaries, Charter provides basic cable, digital cable, high speed internet and telephone services to its customers. Charter's common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and is listed on the NASDAQ National Market.
Summary
2. From the first through the fourth quarters of 2001, Charter inflated the number of customers who subscribed to its services in an attempt to meet analysts' expectations for subscriber growth and depict itself as a growing company. To inflate its subscriber numbers, Charter employees stopped its usual practice of disconnecting the services of delinquent paying customers and customers who had requested the termination of their services. As a result of this conduct, Charter artificially inflated its number of subscribers and subscriber growth that it reported to the Commission and to the public from the first through the fourth quarters of 2001 in its Forms 8-K, Forms 10-Q and Form 10-K.
3. In the fourth quarter of 2000, Charter also inflated its year-end revenue and operating cash flow by $17 million when it realized its year-end revenue and operating cash flow for 2000 was going to be short of analysts' expectations. To do so, Charter entered into one contract under which it agreed to pay two of its digital set-top box suppliers an additional $20 for each set-top box it purchased and simultaneously entered into another contract under which its set-top box suppliers agreed to purchase $20 in advertising services from Charter for each set-top box Charter purchased. In reality, no real revenue was generated from these transactions because Charter provided the suppliers with the money they used to purchase the advertising services from Charter. Charter overpaid approximately $17 million to the two set-top box suppliers and received the same amount back from the two suppliers as advertising revenue in the fourth quarter of 2000. Consequently, Charter improperly inflated its 2000 year-end revenue and operating cash flow that it reported to the Commission and to the public in its Form 10-K for 2000.
Charter's Inflation of Subscriber Numbers
4. Subscriber numbers are an important measure used to rank cable companies and used to predict future cash flow, revenue and company growth. Specifically, Charter's rank as the third largest cable company is dependent on its total number of subscribers. Charter published its subscriber numbers and subscriber growth rate in press releases and reported these figures in quarterly and annual reports filed with the Commission. Further, investment analysts routinely focused on subscriber numbers in their reports and conference calls, among other factors, to make their recommendations and value a cable company's stock.
5. Charter held itself out as an industry leader in subscriber growth. Specifically, in 1999 Charter reported that its basic customer growth of 3.1% exceeded the national average of 1.8%. In 2000, Charter held itself out as an industry leader in subscriber growth by reporting basic subscriber growth of 2.5% for the year. Similarly, in 2001, Charter reported that it continued to pace the industry with customer growth of 1.1%.
6. At the end of each prior year, Charter set its subscriber growth targets for the upcoming year through the company budget process. As part of the budget process, Charter assigned subscriber growth targets to each of its divisions. In turn, the divisions assigned the responsibility of meeting the division's subscriber growth targets to its region and system levels that set subscriber growth targets on a monthly and quarterly basis.
7. Beginning in the first quarter of 2001, Charter began experiencing an increase in the number of customers switching to satellite television service and customers who, at the end of a special price promotion period, either became delinquent in paying their account balances or requested that their service be terminated. As the competition from satellite providers and the number of delinquent paying subscribers increased throughout 2001, some of Charter's regions stopped disconnecting some of its subscribers who Charter would have ordinarily disconnected in order to meet subscriber growth targets. At Charter this process was known as "managing disconnects" or "holding disconnects." By managing or holding disconnects, customers remained in Charter's subscriber count and enabled it to meet subscriber growth targets for the company.
8. Charter had no company-wide policy as to when to disconnect delinquent paying or "non-pay" customers. Some systems at Charter historically disconnected customers when their accounts became 60 to 75 days past due, but during the first through the fourth quarters of 2001 were told not to disconnect these customers in order to inflate subscriber numbers. To this end, Charter allowed accounts for customers' who otherwise would have been disconnected to age well past 60 days to meet subscriber growth targets. Many non-pay customers' accounts were held for more than 90 days and some well over 120 days before being disconnected. By not disconnecting these customers' service, Charter was able to include these customers in its subscriber count.
9. Charter's usual business practice was to disconnect a customer's service within seven to ten days after a customer voluntarily requested termination of their service. To meet subscriber growth targets, however, Charter occasionally ignored this practice by delaying the disconnect of customers' services to beyond seven to ten days. By not timely disconnecting these customers' services, Charter was able to include these customers in its subscriber count.
10. By improperly managing disconnects, Charter was able to tell the public that for the first through fourth quarters of 2001 it was meeting and, at times, exceeding analysts' expectations for subscriber growth when, in fact, Charter actually experienced flat to negative growth for those periods. If, however, Charter employees had followed usual disconnect practices and removed subscribers who should have been disconnected from active subscriber rolls, it would have reported materially lower subscriber totals.
11. As a result of managing disconnects, Charter included materially inflated subscriber numbers in its Forms 8-K containing the press releases on its financial results for the first quarter through fourth quarter of 2001, its Forms 10-Q for the first quarter through the third quarters of 2001 and its Form 10-K for 2001. Thus, by inflating subscriber numbers Charter misstated the number of subscribers and subscriber growth figures it reported to the Commission and falsely depicted itself to the public and analysts as a growing company.
Charter's Inflation of Revenue and Operating Cash Flow
12. In the fourth quarter of 2000, Charter realized that its 2000 year-end revenue and operating cash flow was going to be approximately $17 million short of Charter's budget targets and analysts' expectations. Analysts use these numbers to assess the company's stock value and Charter reports them in its quarterly and annual reports, analyst's conference calls and press releases.
13. To generate additional revenue and operating cash flow in order to overcome the fiscal year 2000 shortfall, Charter devised a scheme to get advertising business from its digital set-top box suppliers. To carry out the scheme, Charter entered into one agreement under which it paid two of its set-top box providers an additional $20 for each set-top box it purchased and simultaneously entered into another agreement under which the two set-top box providers purchased $20 in advertising from Charter for each set-top box Charter purchased. Charter increased its revenue and operating cash flow with the $20 Charter was paid by the suppliers as advertising revenue. In effect, however, no real revenue was generated by these transactions because by paying an additional $20 per set-top box, Charter gave the suppliers the money to purchase the advertising services from Charter.
14. Charter improperly recognized revenue from these transactions because they were barter transactions. According to the principals set forth in SAB 101 and EITF 99-17, revenue cannot be recognized from barter transactions unless there is a determinable fair value. In addition, Charter was advised at the time by its auditor that in order to properly recognize revenue from these transactions and avoid these transactions from being considered barter transactions, the transactions had to be: 1) unrelated to each other; 2) negotiated at least one month apart; and 3) set at fair market value. Instead, Charter negotiated both the set-top box and advertising contracts at the same time in September 2000 and tried to conceal the fact that the contracts were negotiated simultaneously by backdating the set-top box contracts to August 2000. Additionally, the contracts were related given that both contracts were executed to carry out the scheme to raise additional revenue and operating cash flow. Finally, these transactions were not undertaken at the fair value of the time slots purchased because these set-top box suppliers paid four to five times more for their advertisement time slots than other parties had paid Charter for advertisement time slots during 2000.
15. As a result of this scheme, Charter improperly recognized approximately $17 million in advertising revenue and was able to meet analysts' expectations as to revenue and operating cash flow in the fourth quarter of 2000. Consequently, Charter overstated its 2000 year-end revenue and operating cash flow by approximately $17 million in its Form 10-K for 2000.
Charter's Violations of the Exchange Act
16. As a result of the conduct described above, Charter violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11 and 13a-13 thereunder, which require issuers of securities registered pursuant to Section 12 of the Exchange Act to file accurate reports on Forms 10-K, 10-Q and 8-K. These reports must contain any material information necessary to make statements made in the reports not misleading. No showing of scienter is necessary to establish an issuer's violation of the corporate reporting provisions. See SEC v. McNulty, 137 F.3d 732, 740-41 (2d Cir. 1998). As discussed above, Charter violated these provisions by filing periodic reports that misstated its total number of basic subscribers and subscriber growth numbers for the first through fourth quarters of 2001 in its Forms 8-K containing press releases on its financial results from the first quarter through fourth quarter of 2001, its Forms 10-Q from the first quarter of 2001 through the third quarter of 2001 and its Forms 10-K for 2001. In addition, Charter overstated its operating cash flow and revenue for the year-end 2000 in its Form 10-K for 2000.
17. As a result of the conduct described above, Charter also violated Section 13(b)(2)(A) of the Exchange Act and Rule 13b2-1 thereunder. Section 13(b)(2)(A) requires reporting companies registered under Section 12 of the Exchange Act to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the issuer's assets. In addition, Rule 13b2-1 of the Exchange Act prohibits any person from directly or indirectly falsifying any book, record or account required to be kept pursuant to Section 13(b)(2)(A) of the Exchange Act. Charter misstated the number of subscribers it reported in books, records and accounts for the first through fourth quarters of 2001 and overstated its 2000 year-end operating cash flow and revenue by approximately $17 million by improperly recognizing revenue from its set-top box suppliers. Charter violated Rule 13b2-1 when it falsified its books and records by reporting subscribers in its total subscriber count that should have been disconnected, improperly recognizing revenue and operating cash flow from barter transactions and backdating contracts.
18. Further, as a result of the conduct described above, Charter violated Sections 13(b)(2)(B) and 13(b)(5) of the Exchange Act. Section 13(b)(2)(B) requires reporting companies to devise and maintain a system of internal accounting controls sufficient to reasonably assure that transactions are recorded and financial statements are prepared in conformity with GAAP. Additionally, Section 13(b)(5) of the Exchange Act provides that, among other things, no person shall knowingly circumvent or fail to implement a system of internal accounting controls or falsify any book, record or account described in Section 13(b)(2). Charter had no formal policies or procedures sufficient to assure that systems were not managing or holding disconnects in order to artificially inflate subscriber numbers and that employees had properly accounted for revenue and cash flow from barter transactions. Moreover, Charter violated Section 13(b)(5) by instructing systems not to follow the disconnect procedures they did have and allowing employees to backdate the set-top box contracts with its suppliers.
Undertakings
Respondent undertakes to:
A. Assure that public disclosures made by Charter to its shareholders and Commission are accurate and complete, that such disclosures fairly present Charter's financial condition and results of operations, and that such disclosures are made on a timely basis, as required by applicable laws and regulations.
B. Assure that it reports accurate subscriber numbers and subscriber growth, stops the practice of holding disconnects to meet budget targets and complies with the company's new disconnect policies.
C. Assure that internal controls are in place to prevent recurrences of the improper accounting treatment in the fourth quarter of 2000 resulting in Charter overstating its revenue by $17 million. To this end, Charter will undertake certain actions, including, but not limited to, the following: a) assure that barter transactions are afforded the correct accounting treatment under GAAP; and b) develop a system of accounting oversight to assure that contracts are dated properly.
D. Adopt a zero tolerance policy on holding or managing disconnects in order to inflate subscriber numbers and terminate any employee found to be managing or holding disconnects for this purpose. In addition, Charter's Chief Executive Officer will issue quarterly written reminders to all employees regarding Charter's zero tolerance policy for holding or managing disconnects in order to inflate subscriber numbers.
E. Institute a formal written policy that details disconnect procedures for terminating the service of delinquent paying subscribers. This policy will require that delinquent paying customers' service be terminated 60 to 75 days after their account balance becomes past due ("termination date") and that their balances be written off to bad debt 90 to 110 days after their account balances become past due ("write off date"). Charter may specifically identify a few categories of subscribers that, for historical business reasons, Charter permits to remain as active subscribers for more than 75 days after a bill becomes past due. Any exceptions Charter makes to allow a delinquent paying customer to remain an active subscriber after 75 days of non-payment shall be documented, reviewed and approved by Key Market Area management personnel at or before the close of each billing cycle. Division level management shall also review and approve these documented exceptions to Charter's formal written disconnect policy at or before the close of each billing cycle. In its formal written disconnect policy, Charter shall identify these categories of subscribers and describe for each the reasons for making an exception to its formal written disconnect policy as well as termination dates and write off dates applicable to each exception. Charter may periodically add, subtract or change the categories of customers excepted from its formal written disconnect policy with an appropriate disclosure in its public filings with the Commission. In the cases of any exceptions made to Charter's formal written disconnect policy, Charter may not keep any delinquent paying subscribers on its subscriber rolls for the purpose of increasing reported subscriber numbers.
F. Establish a Corporate Director of Credit and Collections who is responsible for monitoring Charter's credits and collections and developing reports that monitor bad debt on a monthly basis. These reports will be distributed to Charter's Chief Operating Officer and to the Legal Department who will investigate and remedy instances when bad debt may be rising and ensure that employees are promptly disconnecting non-paying subscribers.
G. Reform its Corporate Compliance Program by, among other things, establishing a web site and toll-free telephone number managed by an independent third party through which employees can report suspected violations of its accounting procedures and code of ethics. In addition, Charter will establish a Compliance Committee to evaluate suspected violations, conduct investigations and make disciplinary recommendations.
H. Cease considering the achievement of subscriber growth targets as a component of employee bonuses.
I. Replace its top-down budget process with a bottom-up budget process that eliminates industry analysts' projections as a component of setting Charter's budget goals.
J. Include a disclosure in its quarterly and annual filings with the Commission as to the number of active subscribers whose accounts are more than 60 days, 90 days and 120 days past due.
K. Instruct its internal auditors to review compliance with Charter's formal disconnect procedures on a quarterly basis and report the findings to its public auditors in connection with its annual audit.
L. Any undertakings set forth in Section III above which were implemented prior to the date of this Order shall be maintained.
Remedial Efforts by Charter Communications
19. In determining to accept the Offer, the Commission considered remedial acts promptly undertaken by Respondent and cooperation Respondent afforded the Commission staff.
IV.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Charter's Offer.
Accordingly, it is hereby ORDERED:
A. Pursuant to Section 21C of the Exchange Act, that Charter cease and desist from committing or causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and 13(b)(5) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, 13a-13 and 13b2-1 thereunder; and
B. Charter shall comply with the undertakings enumerated in Section III above.
By the Commission.
Jonathan G. Katz
Secretary