UNITED STATES DISTRICT COURT
COMPLAINT FOR INJUNCTIVE AND OTHER RELIEF
The Securities and Exchange Commission ("the Commission") alleges:
SUMMARY OF THE COMPLAINT
1. Defendant Nelson Barber, while the chief financial officer of Fine Host Corporation, caused Fine Host to engage in an extensive financial fraud that, when detected, resulted in the collapse of its stock price and, eventually, the end of its existence as a public company. The scheme predated Fine Host's June 1996 initial public offering by several years and continued through the third quarter of the fiscal year ended December 31, 1997. The primary mechanism of the fraud was the improper capitalization of millions of dollars of Company expenses as assets. Barber, alone or with others, also manipulated acquisition reserve accounts, income from vendor rebates, and other items for the purpose of managing reported earnings.
2. Based on an internal investigation, Fine Host restated its financial statements in February 1998, admitting that from 1992 through the third quarter of fiscal year 1997, it had overstated its pretax income by over $49 million. For fiscal years 1994, 1995 and 1996, Fine Host had overstated pretax income by approximately 149%, 213%, and 197%, respectively. For the first, second, and third quarters of fiscal 1997, the Company overstated its pretax income by 324%, 320%, and 170%, respectively.
3. Defendant Barber was at least reckless in preparing financial statements that were not in conformity with generally accepted accounting principles ("GAAP"), maintaining false and misleading books and records, and failing to maintain a system of internal accounting controls sufficient to prevent the recording of improper adjustments. This conduct violated the anti-fraud, reporting, books and records and internal controls provisions of the federal securities laws, as specified below.
4. By virtue of the conduct described herein, defendant Barber violated Section 17(a) of the Securities Act of 1933 ("Securities Act") [15 U.S.C. § 77q(a)], Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78j(b), 78m(b)(5)] and Rules 10b-5, 13b2-1, and 13b2-2, promulgated thereunder [17 C.F.R. 10b-5, 13b2-1, and 13b2-2].
5. By virtue of the conduct described herein, defendant Barber aided and abetted violations by Fine Host of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act [15 U.S.C. §§ 78m(a), 78m(b)(2)(A), and 78m(b)(2)(B)] and Exchange Act Rules 12b-20, 13a-1 and 13a-13 thereunder [17 C.F.R. 240.12b-20, 13a-1, and 13a-13].
JURISDICTION AND VENUE
6. This Court has jurisdiction over this action under Section 20(b) of the Securities Act [15 U.S.C. § 77t(b)] and Sections 21(d), 21(e), and 27 of the Exchange Act [15 U.S.C. §§ 78u(d), 78u(e), and 78aa]. Venue lies in this Court pursuant to Section 20 of the Securities Act and Section 27 of the Exchange Act.
7. In connection with the transactions, acts, practices, and courses of business described in this Complaint, the defendant, directly and/or indirectly, made use of the means or instrumentalities of interstate commerce, of the mails, and/or of the means or instrumentalities of transportation or communication in interstate commerce.
8. Nelson Barber served as Senior Vice President and CFO of Fine Host Corporation from 1995 to April 1997. He continued to work for the Company in the capacity of Treasurer until December 1997, when he was terminated by the board of directors. He is a certified public accountant, licensed in Connecticut.
9. Fine Host Corporation is a Connecticut-based company that, at all times relevant to this Complaint, provided food and beverage concession, catering and other services to approximately 400 facilities in 38 states. Fine Host conducted an initial public offering in June 1996, and a secondary offering in February 1997. Its stock was registered with the Commission under Section 12(g) of the Exchange Act and listed for trading on the Nasdaq National Market System. On January 7, 1999, subsequent to the extensive restatement of its financial statements, Fine Host entered a proceeding under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to its plan of reorganization, Fine Host has now become a private entity.
The Improper Accounting for "Contract Rights"
10. Fine Host's operations were based on securing contracts to provide food services to sports arenas, schools, convention centers, and other facilities. Beginning when Fine Host was a private company, its accounting practice, as directed by the defendant, was to aggregate certain costs associated with the pursuit of those contracts in an "acquisition costs" account. When a contract was signed, the costs attributed to it were then transferred to the "contract rights" account and were treated as capitalized costs to be amortized over the term of the contract. (In addition, substantial amounts of these costs were improperly capitalized in "fixtures and equipment" accounts, particularly in 1996 and 1997.)
11. This practice was permissible under GAAP only to the extent these costs were directly related to the acquisition of assets with a future economic benefit to Fine Host. The defendant, however, routinely and improperly allocated a pool of General and Administrative ("G&A") expenses to the contract rights account, without sufficient support for this practice, rather than properly recognizing these overhead costs as period expenses. Each quarter, the defendant assigned a certain (arbitrarily determined) percentage of total costs to each facility, and then allocated costs to specific facilities by multiplying the total costs for the quarter by the facility's assigned percentage.
12. The improper treatment of contract acquisition costs in the period preceding Fine Host's IPO was material. In its restatement, Fine Host wrote-off $2,458,000 of such costs as improperly capitalized in 1994, representing approximately 75% of pretax income for the year. For 1995, Fine Host wrote-off $4,384,000 in contract acquisition costs, approximately 116% of pretax income for the year.
The Improper Accounting for Acquisition Reserves
13. Fine Host regularly acquired other companies in the food services industry. These acquisitions provided another vehicle for the defendant, alone or with others, to manipulate Fine Host's earnings. For each acquisition, Fine Host would, at defendant's direction, set up goodwill and an acquisition reserve. These reserves were then used by defendant, alone or with others, as a "cookie jar" to offset losses on a purely discretionary basis, sometimes two or three years after the acquisition In many instances, Fine Host did not discontinue any activity in connection with these acquisitions, or incur costs related to these acquisitions, such as those for terminated employees. Fine Host did not have sufficient documentation to support the amount taken as a reserve.
The Fine Host IPO
14. Fine Host filed the registration statement for its IPO on March 29, 1996. In its Form S-1, the Company reported results of operations for the fiscal years 1993 through 1995. Defendant, alone or with others, prepared the financial information contained in the registration statement. Defendant Barber, in addition, signed a management representation letter to the Company's independent accountants, stating that the Company's financial statements, as included in the registration statement, had been prepared in conformity with GAAP, although he knew, or was reckless in not knowing, that this representation was materially false and misleading.
15. The staff of the Commission's Division of Corporation Finance reviewed the registration statement and commented upon it in detail. Defendant participated in the communications between the Company and the Commission staff. The Commission staff specifically questioned Fine Host's accounting policy for contract rights. In response, Fine Host, with Barber's knowledge, represented that, for all periods after year-end 1995, it would capitalize only two categories of costs associated with contract acquisitions: direct payments made to clients to acquire the contracts and the direct costs of obtaining licenses and permits to operate its contract locations. Fine Host, with Barber's knowledge, specifically represented that it would no longer capitalize commissions and proposal costs. Finally, Fine Host, with Barber's knowledge, represented that it had not amended its financial statements for the years covered by the registration statement to conform to this policy "since the impact of this adjustment would not be material for any year presented." In fact, as Barber knew, or was reckless in not knowing, the misstatement of Fine Host's financial results due to improper capitalization of contract rights was material for each fiscal year 1993 through 1995.
16. The Fine Host registration statement became effective on June 19, 1996, with net proceeds to the Company of approximately $32 million. The 1994 and 1995 year-end financial statements contained in the registration statement were materially false and were subsequently restated.
The Fiscal Year Ended December 25, 1996
17. Following the IPO, Fine Host, at defendant's direction, continued to accumulate costs in its acquisition cost account and later "reclass" them either to the contract rights account or fixtures and equipment account for capitalization and amortization. In fiscal year 1996, total additions to contract rights totaled approximately $12.2 million, and additions to the fixtures and equipment account approximated $16.5 million.
18. The items capitalized went well beyond both the cost categories Fine Host had represented to the Commission staff it would capitalize in the future and the capitalized cost categories it represented in its 1996 Form 10-K. In Fine Host's restatement, approximately $6.3 million of capitalized 1996 contract acquisition costs were reversed as improper. This represented approximately 98% of Fine Host's pretax income for the entire year.
19. During 1996, Fine Host, at defendant's direction, also misused acquisition reserves. Fine Host improperly lowered its expenses by offsetting approximately $2.65 million in operating expenses against previously recorded acquisition reserves. This inflated Fine Host's pretax income by approximately 41%.
20. In connection with the audit of Fine Host's year-end 1996 financial statements, defendant signed a management representation letter to the Company's independent accountants, stating that the Company's financial statements, as incorporated into its annual filing on Form 10-K, had been prepared in conformity with GAAP, although he knew, or was reckless in not knowing, that this representation was materially false and misleading.
21. By the autumn of 1997, amortization of Fine Host's growing contract rights balance was reducing reported earnings, and Fine Host was experiencing difficulty in meeting analysts' expectations. Alerted by a member of management that certain of the Company's accounting practices were questionable, the independent directors initiated an internal investigation. In February 1998, at the conclusion of this investigation, Fine Host announced that it had overstated its pretax net income by approximately $49 million, from approximately 1992 through the third quarter of 1997.
22. In Fine Host's restatement, eighteen categories of material accounting errors were identified, with improperly capitalized contract rights of approximately $21.7 million being the largest. Acquisition reserves totaling approximately $8.4 million were written off because (i) they were costs that should have been expensed as incurred, (ii) the Company lacked documentation linking them to a particular acquisition, or (iii) the reserve, when properly decreased, already had been exhausted. In addition, Fine Host wrote off purported rebates receivable in the amount of approximately $5.5 million, because they were supported by little, if any, documentation.
23. On January 7, 1999, Fine Host entered a proceeding under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to its plan of reorganization, Fine Host has now become a private entity.
24. Plaintiff realleges and incorporates by reference paragraphs 1 through 23 above.
25. Defendant Barber, directly or indirectly, by use of the means or instruments of transportation or communication in interstate commerce, or by the use of the mails and of the facilities of a national securities exchange, in connection with the offer, purchase or sale of securities: has employed devices, schemes, or artifices to defraud, has made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or has engaged in acts, practices, or courses of business which operate or would operate as a fraud or deceit upon any person.
26. By reason of the foregoing, Defendant Barber has, directly or indirectly, violated and aided and abetted violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
27. Plaintiff realleges and incorporates by reference Paragraphs 1 through 23 above.
28. Defendant Barber caused Fine Host to file materially false and misleading annual reports on Form 10-K and materially false and misleading quarterly reports on Form 10-Q with the Commission during the period from June 1996 through November 1997.
29. By reason of the foregoing, Defendant Barber aided and abetted violations by Fine Host of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
Violations of Sections 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act [15 U.S.C. §§ 78m(b)(2)(A), 78m(b)(2)(B), and 78m(b)(5)] and Rule 13b2-1 [17 C.F.R. § 240.13b2-1] thereunder.
30. Plaintiff re-alleges and incorporates by reference the allegations contained in Paragraphs 1 through 23 above.
31. Defendant Barber aided and abetted failures by Fine Host to make and keep books, records and accounts which accurately and fairly reflected its transactions and dispositions of its assets, in violation of Section 13(b)(2)(A) of the Exchange Act, and further aided and abetted failures to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that Fine Host's corporate transactions were executed in accordance with management's authorization and in a manner to permit the preparation of financial statements in conformity with generally accepted accounting principles, in violation of Section 13(b)(2)(B) of the Exchange Act.
32. By engaging in the conduct described above, Defendant Barber, directly or indirectly, falsified and caused to be falsified Fine Host's books, records, and accounts subject to Section 13(b)(2)(A) of the Exchange Act, in violation of Exchange Act Rule 13b2-1.
33. By engaging in the conduct described above, Defendant Barber knowingly circumvented or knowingly failed to implement a system of internal financial controls at Fine Host, in violation of Section 13(b)(5) of the Exchange Act.
Violations of the Exchange Act Rule 13b2-2 [17 C.F.R. § 240.13b2-2]
34. The Commission re-alleges and incorporates by reference the allegations contained in Paragraphs 1 through 23 above.
35. Defendant Barber, directly or indirectly, made or caused to be made false and misleading statements or omitted or caused others to omit to state material facts necessary in order to make statements made, in light of the circumstances under which such statements were made, not misleading to Fine Host's independent accountants in connection with audits of Fine Host's required financial statements and in connection with the preparation and filing of documents and reports required to be filed with the Commission, in violation of Exchange Act Rule 13b2-2.
PRAYER FOR RELIEF
WHEREFORE, the Commission respectfully requests that this Court:
(a) based on violations of the Acts and Rules specified herein, permanently enjoin Defendant Barber from violating and/or aiding and abetting violations of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, and 13b2-2 thereunder;
(b) order Defendant Barber to pay civil penalties pursuant to Section 20(d) of the Securities Act and Sections 21(d)(3) of the Exchange Act;
(c) permanently bar Defendant Barber from serving as an officer or director of a public company; and
(d) grant such other relief as this Court may deem appropriate.