UNITED STATES DISTRICT COURT
Plaintiff Securities and Exchange Commission alleges:
1. Before it was acquired in December 2000, Telxon Corporation was a leading manufacturer of hand held computing devices and related systems. In late September 1998, Telxon's former Chief Financial Officer, Kenneth W. Haver, caused Telxon to improperly recognize revenue for three purported sales transactions. These transactions inflated Telxon's quarterly revenues by 23% and quarterly profits by 270%.
2. Later in 1998, a competitor approached Telxon about a potential merger and discovered one of the fraudulent transactions during due diligence. Telxon restated that transaction in December 1998 and, following a general accounting review, Telxon announced additional restatements in February 1999, June 1999 and July 2000.
3. In causing Telxon to improperly recognize revenue in September 1998, and in connection with the additional matters restated in 1999 and 2000, Haver knowingly or recklessly violated or aided and abetted violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. §§ 78j(b), 78m(a), 78m(b)(2)(A), 78m(b)(2)(B) and 78m(b)(5)] and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 [17 C.F.R. §§ 240.10b-5, 240.12b-20, 240.13a-1, 240.13a-13 and 240.13b2-1] thereunder. By this action, the Commission seeks a final judgment permanently enjoining Haver from such violations, and the imposition of a civil penalty under Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)].
4. This Court has jurisdiction over this action under Sections 21(d), 21(e) and 27 of the Exchange Act [15 U.S.C. §§ 78u(d), 78u(e) and 78aa].
5. In connection with transactions, acts, practices, and courses of business described in this Complaint, Haver has, directly and 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.
6. Defendant Kenneth W. Haver is 43 years old and is a resident of Akron, Ohio. He was Telxon's Chief Financial Officer from March 1995 through February 1999.
7. Telxon Corporation is a Delaware corporation based in Akron, Ohio. Before a competitor acquired the company in December 2000, it was a leading manufacturer of hand held computing devices and related systems. Prior to its acquisition, Telxon's stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act [15 U.S.C. § 78(g)], and was listed on the NASDAQ national stock trading system.
8. In mid-1997, a competitor confidentially informed Telxon that it was interested in pursuing a business combination. In April 1998, the competitor publicly announced an interest in acquiring all of Telxon's outstanding shares for $38 per share, a significant premium over Telxon's then stock market price. In June 1998, the competitor increased the proposed offer to $40 per share in cash or up to $42 per share in cash and stock. Telxon's board of directors rejected the proposals. At about the same time, the local press reported that Telxon officers made public statements predicting the company would achieve improved financial results.
Fraudulent September 1998 Transactions
9. At the end of Telxon's September 1998 quarter, Haver caused Telxon to improperly recognize revenue in connection with three transactions: (i) a shipment to a distributor; (ii) a guaranteed lease-purchase; and (iii) a software sale. These transactions inflated Telxon's quarterly revenues by approximately 23% (from $101.2 million to $124.3 million) and its pretax profits by approximately 270% (from a $7.3 million loss to a profit of $4.1 million).
10. In 1997, Telxon planned to sell some of its products indirectly by recruiting distributors that it referred to as "Value Added Distributors" ("VAD"). One such VAD, located in the Midwest, received a shipment of $4.2 million of Telxon's products in June 1998. The VAD still held some of this product when, the following July or August, Telxon and the VAD discussed major increases in shipments to the VAD -- $14 million more in the September 1998 quarter, and up to $20 million more in the following quarter. The VAD understood that Telxon would be responsible for selling these goods, and it agreed to accept the future shipments.
11. In mid-to-late September 1998, Haver and another Telxon official asked the VAD if Telxon could get paid on shipment of the new product. The distributor put Telxon in contact with its financing company to arrange the payment. On September 30, Telxon and the financing company signed a "vendor" agreement, and the distributor and the financing company signed a "consignment" agreement. Pursuant to these contracts, Telxon shipped $14.1 million of goods to the distributor on September 30, and the financing company wired $14.1 million to Telxon. Haver negotiated and signed the financing agreement with the financing company on behalf of Telxon. Title to the goods passed to the financing company; the financing company consigned the goods to the distributor; Telxon agreed to pay fees to the financing company, based in part on the balance of unsold goods held by the distributor. Telxon also agreed to pay monthly fees and handling charges to the VAD. The VAD would collect customer payments for wire transfer to the financing company. The financing company retained an unrestricted right to repossess the goods from the distributor and put them back to Telxon for immediate and full payment. As of September 30, no end-user or customer had placed an order with either Telxon or the distributor for any of the $14.1 million of goods shipped to the distributor pursuant to the contracts described in this paragraph.
12. Recognition of revenue in connection with this transaction was not in conformity with Generally Accepted Accounting Principles ("GAAP"). The group of agreements was, in substance, a product financing arrangement, which is governed by Statement of Financial Accounting Standards ("SFAS") No. 49, Accounting for Product Financing Arrangements (June 1981) and which precludes revenue recognition in this situation. More fundamentally, the transaction was not a sale or an "earning[s] process," as revenue had not been realized and earned. See, FASB Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (December 1984), paragraphs 83-84. Telxon retained substantially all risks of ownership in the merchandise that had shipped on September 30, 1998; the VAD had almost no risk at all; the ostensible "owner" was a financing company that had no means of using or selling the product.
13. In the summer of 1998, Telxon negotiated a sale to a company that operated a chain of hardware stores. It was well known at the time that this company was in very poor financial condition. On September 30, Telxon shipped merchandise to the hardware chain and recognized revenue of approximately $7 million. Title to the goods transferred to a leasing company, and the hardware chain signed a long-term lease with the leasing company. Telxon also signed a separate agreement with the leasing company, dated September 29, 1998, by which Telxon guaranteed the hardware chain's lease payments to the leasing company. The leasing company paid Telxon for the merchandise, pursuant to the lease contract with the hardware chain. The hardware chain filed a bankruptcy petition and defaulted on the lease within months, and the leasing company demanded full payment on the lease from Telxon.
14. Haver negotiated and signed the lease guarantee on Telxon's behalf. Telxon's recognition of this revenue was not in conformity with GAAP. Pursuant to SFAS No. 13, Accounting for Leases (November 1976), paragraphs 21-22, "the sale of property [subject to a lease] shall not be treated as a sale if the seller . . . retains substantial risks of ownership in the leased property." Because Telxon guaranteed the lease payments to the leasing company, Telxon retained substantial risks of ownership.
15. In late September 1998, Telxon officials proposed a sale of customized software to a company that operated a nationwide chain of retail stores and which was one of Telxon's biggest customers. The retail chain agreed to the purchase in principle and negotiated a price of $2 million, but informed Telxon that the base software would need to be upgraded to meet its needs. The retail chain provided Telxon with detailed specifications for the upgrades on October 2, 1998. Telxon agreed to the specifications, and the retail chain issued a purchase order for the software on October 5, 1998. In the purchase order, the retail chain stated that the price included all future updates and maintenance, and that payment was contingent upon (i) "fault free performance," (ii) "complete installation . . . in all [end user] business units," and (iii) "the requirements noted in Attachment `A' [that is, the specifications dated October 2, 1998]." Telxon's chief technical officer estimated that his department needed three to six months to write the software code for the upgrades required by the retail chain.
16. Following the receipt of the retail chain's purchase order, Haver and other Telxon officials met and discussed the state of completion of the software. At or following this meeting, it was decided that Telxon would recognize $2 million of revenue for the retail chain's software, as of September 30, 1998.
17. Recognition of this revenue was not in conformity with GAAP. For software sales, GAAP require, inter alia, "persuasive evidence of an arrangement" and delivery of the software as of the date of recognition. Also, if "uncertainty exists about customer acceptance" after delivery, revenue should not be recognized. See, Statement of Position ("SOP") 97-2, Software Revenue Recognition (October 1997), paragraphs 8, 20. The retail chain's purchase order highlighted several significant uncertainties as to acceptance. The evidence of an arrangement between Telxon and the retail chain as of September 30, 1998, was not "persuasive," given that the retail chain did not supply its specifications for upgrades until October 2, or a purchase order until October 5. Likewise, software that was not in existence as of September 30 can not have been delivered as of that date. In addition, Telxon's agreement to provide future upgrades and maintenance required deferral of at least a portion of the revenue. See, SOP 97-2, paragraph 9. Telxon never delivered a product to the retail chain that contained the required upgrades, and the retail chain never paid the $2 million.
Telxon Files Materially False and Misleading Form 10-Q for September 1998
18. On November 16, 1998, Telxon filed its quarterly report on Form 10-Q for the quarter ended September 30, 1998 with the Commission. The Form 10-Q, which was signed by Haver, contained financial statements that were materially false and misleading because they included the revenues and profits derived from the distributor shipment, the guaranteed lease-purchase, and the software sale described above, for which revenue recognition was not in conformity with GAAP. Haver oversaw the preparation of those financial statements and approved their issuance and inclusion in the Form 10-Q. On October 20, 1998, Telxon also issued a press release announcing preliminary results for the quarter ended September 30, 1998. The press release was materially false and misleading because it incorporated and reported Telxon's fraudulently inflated revenues and profits for the quarter.
Problem Assets Affecting Prior Fiscal Years
19. As of March 31, 1998, Telxon had significant assets on its balance sheet for which collectability was in doubt or dispute, or which had been incorrectly recorded in the first place. These assets arose mainly from transactions with four distributors or customers: (i) equity and notes receivable derived from the sale and licensing of a software business to a company operated by a former Telxon employee, in 1996 and 1997; (ii) equity, notes receivable, and accounts receivable derived from sales to Telxon's Mexican distributor in 1997 and 1998; (iii) a lease-purchase by an insurance company in 1997; and (iv) sales to a VAD in 1997 and 1998.
20. In February 1999, June 1999 and June 2000, Telxon restated certain transactions related to these four customers. Telxon also restated many other smaller transactions, which were mostly a question of timing (that is, the restated revenues were not written off completely, but moved from one period to another). Without taking into account the smaller transactions, restating these transactions had the effect of: (i) for the fiscal year ended March 31, 1996, reducing Telxon's pre-tax profits by $2 million, from $26.83 million to $24.83 million; (ii) for the fiscal year ended March 31, 1997, increasing Telxon's pre-tax loss by $3.7 million, from ($5.69 million) to ($9.39 million); and (iii) for the fiscal year ended March 31, 1998, reducing Telxon's pre-tax profit by $12.9 million, from $28.85 million to $15.95 million.
21. As to the software sale and license, Telxon had received no payments after March 1997 because of a dispute that had arisen between Telxon and the buyer over amounts due on a cross-license arrangement. Nevertheless, Telxon continued to record revenues and expenses as they became due on the licenses through December 1998. Telxon did not record a charge to income in connection with the increasing unpaid balance due from the software buyer/licensee.
22. As to the Mexican distributor, financial problems led to delays in payment beginning in 1997. Nevertheless, Telxon continued to ship product to the distributor and to record revenues through November 1998. Telxon did not record a charge to income in connection with the increasing unpaid balance due from the distributor.
23. The slowed and/or stopped payments by the software buyer and the Mexican distributor were an indication that, by fiscal year end March 31, 1998, at the latest, these accounts were potentially impaired and a charge to income needed to be taken. These two accounts were discussed generally among Telxon's management, but no action was taken until the accounting review that began in 1999. As Telxon's CFO, Haver had primary responsibility for the accounting for these transactions. The revenues and profits derived from the Mexican distributor and the software sale were incorporated into Telxon's annual financial statements for the year ended March 31, 1998, and caused those financial statements to be materially false and misleading. Those financial statements were included in Telxon's Form 10-K for the fiscal year ended March 31, 1998, which was filed with the Commission and disseminated to the public.
FIRST CLAIM FOR RELIEF
Haver Violated Section 10(b) of the
24. Paragraphs 1 through 23 above are realleged and incorporated by reference herein.
25. Defendant Haver knowingly or recklessly participated in misrepresentations and omissions of fact with the intent of materially overstating Telxon's revenues and profits for the quarter ended September 30, 1998.
26. By reason of the foregoing, Defendant Haver violated Section 10(b) of the Exchange Act [15 U.S.C. § 78j(b)] and Rule 10b-5 [17 C.F.R. § 240.10b-5] thereunder.
SECOND CLAIM FOR RELIEF
Haver Violated Section 13(b)(5) of the
27. Paragraphs 1 through 26 above are realleged and incorporated by reference herein.
28. By reason of the foregoing, Haver violated Section 13(b)(5) of the Exchange Act [15 U.S.C. § 78m(b)(5)] by knowingly circumventing, or knowingly failing to implement, a system of internal accounting controls at Telxon, or knowingly falsifying the books, records, or accounts of Telxon. Haver also violated Rule 13b2-1 of the Exchange Act [17 C.F.R. § 240.13b2-1], by, directly or indirectly, falsifying or causing to be falsified, the books, records or accounts of Telxon subject to Section 13(b)(2)(A) of the Exchange Act [15 U.S.C. § 78m(b)(2)(A)].
THIRD CLAIM FOR RELIEF
Haver Aided and Abetted Telxon's Violations
29. Paragraphs 1 through 28 above are realleged and incorporated by reference herein.
30. As alleged more fully above, Telxon filed with the Commission materially false and misleading financial statements for its fiscal year ended March 31, 1998, and for the fiscal quarter ended September 30, 1998, as part of its annual report on Form 10-K and quarterly report on Form 10-Q, respectively.
31. Telxon also failed to make and keep books, records, and accounts that, in reasonable detail, accurately and fairly reflected the transactions and disposition of its assets. In addition, Telxon failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles, or any other applicable criteria and to maintain accountability for assets. As a result of the foregoing, Telxon violated 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 Rules 12b-20, 13a-1 and 13a-13 [17 C.F.R. §§ 240.12b-20, 240.13a-1 and 240.13a-13] thereunder.
32. Defendant Haver knowingly provided substantial assistance to Telxon in connection with its violation 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 Rules 12b-20, 13a-1 and 13a-13 [17 C.F.R. §§ 240.12b-20, 240.13a-1 and 240.13a-13] thereunder.
33. By reason of the foregoing, Defendant Haver aided and abetted Telxon's violation 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 Rules 12b-20, 13a-1 and 13a-13 [17 C.F.R. §§ 240.12b-20, 240.13a-1 and 240.13a-13] thereunder.
PRAYER FOR RELIEF
WHEREFORE, the Commission respectfully requests that this Court enter a judgment:
(i) permanently enjoining defendant Haver from, directly or indirectly, violating Sections 10(b) and 13(b)(5) of the Exchange Act [15 U.S.C. §§ 78j(b) and 78m(b)(5)] and Rules 10b-5 and 13b2-1 [17 C.F.R. §§ 240.10b-5 and 240.13b2-1] thereunder, and from aiding and abetting the violation 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 Rules 12b-20, 13a-1 and 13a-13 [17 C.F.R. §§ 240.12b-20, 240.13a-1 and 240.13a-13] thereunder;
(ii) ordering defendant Haver to pay a civil penalty pursuant to Section 21(d)(3) of the Exchange Act [15 U.S.C. § 78u(d)(3)]; and
(iii) granting such other and further relief as this Court deems necessary and appropriate under the circumstances.