U.S. Securities and Exchange Commission
SEC v. Donald K. McGhan, Civ. Action No. 00CV00475
Litigation Release No. 16466 / March 8, 2000
Accounting and Auditing Enforcement Release No. 1234 / March 8, 2000
SEC Files Settled Financial Fraud Case Against Inamed Corporation's
Former CEO Donald McGhan
The Securities and Exchange Commission filed today a settled civil injunctive action against Donald K. McGhan, Inamed Corporation's former Chairman and Chief Executive Officer. The complaint alleges that in 1996 and 1997, Inamed Corporation, a publicly owned breast implant manufacturer, made materially false and misleading statements and omissions in its financial statements and periodic reports filed with the Commission and in press releases distributed to the investing public. As Inamed's former Chairman and Chief Executive Officer, McGhan was responsible for the company's public financial disclosures and either knew or was reckless in not knowing of the company's materially false and misleading statements and omissions during this period. Without admitting or denying the allegations of the complaint, McGhan consented to the entry of a final judgment permanently enjoining him from violating the antifraud, record-keeping and internal controls provisions of the federal securities laws [Sections 10(b) and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 10b-5 and 13b2-1, thereunder], and ordering him to pay a $50,000 civil penalty.
The complaint alleges that Inamed failed to record a $1.4 million interest expense relating to a waiver of an indenture default and thus materially overstated income and shareholder equity for the quarter ended June 30, 1996. McGhan signed the Form 10-Q and knew or was reckless in not knowing that it contained false and misleading financial statements. For the quarter ended September 30, 1996, the complaint alleges that McGhan knowingly or recklessly caused Inamed to improperly reduce the allowance for product returns by nearly $1.9 million from the prior quarter, which resulted in material overstatements in Inamed's pre-tax income and shareholder equity.
The complaint also alleges that between May and September 1997, McGhan was unable to resolve Inamed's several outstanding issues with its auditors. On September 9, 1997, over five months after the required filing date, McGhan reviewed and authorized Inamed's filing of its Annual Report on Form 10-K with unaudited financial statements. Where the auditor's report should have been located in the Form 10-K, Inamed simply inserted the notation "To Come." McGhan caused Inamed to make the filing without informing its auditors, whose work on the audit continued, and without a chief financial officer to review the financial statements. Inamed again understated its allowance for product returns and incorrectly recorded a deferred tax asset of $2,022,382. Moreover, Inamed failed properly to account for its intercompany transfers of inventory and the concomitant elimination of intercompany profit, resulting in approximately a $1.2 million overstatement of inventories and gross profit. The cumulative effect of these misstatements was that Inamed reported a net loss of $7,071,660, or $0.91 per share, when it should have reported a net loss of at least $11,379,000, or $1.46 per share, a 60% understatement. Thus, had Inamed correctly reported its losses, the company's losses on a per share basis would have increased substantially from the prior year, rather than remaining the same. The complaint alleges that McGhan knew or was reckless in not knowing that Inamed's unaudited financial statements in its 1996 Form 10-K were false and misleading. Inamed also failed to disclose a related party transaction between the company and an entity controlled by McGhan.
The complaint also alleges that in connection with a default of a covenant relating to approximately $6 million of convertible debentures issued in January 1997, Inamed, at the direction of McGhan, failed to disclose either the default or the additional costs associated with the default in its quarterly reports for the periods ended March 31, June 30 and September 30, 1997. As a result Inamed failed to report interest expense of $192,067 for the period ended March 31, 1997, $736,000 for the six months ended June 30, 1997 and $1.2 million for the nine months ended September 30, 1997. The default costs alone caused Inamed's income to be materially overstated in each of its 1997 Form 10-Qs.
In a related cease-and-desist proceeding, In the Matter of Inamed Corporation (Admin. Proc. No. 3-9976, August 17, 1999), the Commission entered a settled order against Inamed Corporation ordering it to cease-and-desist from violations from Sections 10(b), 13(B)(2)(A) and 13(B)(2)(B) of the Exchange Act and Rule 10b-5 thereunder.