SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 17564 / June 14, 2002
Accounting and Auditing Enforcement Release No. 1577 / June 14, 2002
SEC Settles Charges against John Daws for His Involvement in Financial Reporting Fraud at Cylink Corporation
Securities and Exchange Commission v. John Daws, Thomas Butler and Mark Folit, United States District Court for the Northern District of California, Civil Action No. C 01-3362 VRW
The Securities and Exchange Commission announced that on May 15, 2002, the Honorable Vaughn Walker, United States District Judge for the Northern District of California, issued a Final Judgment of Permanent Injunction and Other Relief against John H. Daws, the former Chief Financial Officer of Cylink Corporation.
Without admitting or denying the Commission's allegations, Daws consented to the entry of a final judgment that: permanently enjoins him from violating the antifraud provisions (Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder); from circumvention of Cylink's internal controls and falsification of records (Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder); from making misrepresentations or material omissions to accountants (Rule 13b2-2); and from aiding and abetting Cylink's violations of the periodic reporting and books and records provisions (Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder).
In addition, the final judgment orders him to disgorge ill-gotten gains which he had received in the form of a performance bonus of $30,000, to pay prejudgment interest and to pay a civil penalty of $100,000.
The Commission's complaint, filed on September 27, 2000, alleged that in order to meet Cylink's ambitious revenue goals, Daws, in conjunction with other former Cylink officers, led the Company to recognize revenue on numerous transactions that violated Cylink's own revenue recognition policy, generally accepted accounting principles, or both, for the fourth quarter of 1997 and the first two quarters of fiscal 1998.
The complaint alleges that in the fourth quarter, Daws directed that Cylink improperly recognized revenue for Cylink's wireless division on a $3.7 million shipment to a warehouse in which the transaction was not final because Cylink's customer had failed to provide a letter of credit to support its order. The complaint further alleges that Daws failed to disclose this material information about the transaction to the firm's outside auditors, PriceWaterhouseCoopers, in connection with the 1997 audit. Because Cylink sold its wireless division to another company in early 1998, the effect of this transaction appears in Cylink's restated financial statements in the line item for income from discontinued operations.
In addition, the complaint alleges that, in the second quarter of fiscal 1998, Cylink recognized over $900,000 in revenue on a transaction that was not final because the customer still had up to 90 days to cancel the order. In another instance alleged in the complaint, Cylink recognized revenue on orders from a distributor even though the defendants had reason to believe the distributor could not pay for the product. The complaint also alleges that Cylink recognized revenue on software product orders that were contingent on the customers' rights to exchange the software for Cylink hardware products. Cylink overstated its quarterly revenue by as much as 97.5% during the period of the fraud, according to the Complaint.
After the fraud was uncovered, Cylink issued restated financials that sharply reduced its results for the periods in question. For the year-ended 1997, Cylink reported revenue of $49.3 million, income from discontinued operations of $4.5 million and a net loss of $58.8 million. Cylink's restatement reduced revenue to $47.7 million, reduced income from discontinued operations to $3.2 million and widened the net loss to $61.7 million. Originally reported revenue and earnings from discontinued operations were overstated 3.4% and 41.7%, respectively. The originally reported net loss was understated by 4.8%.
For the first quarter of fiscal 1998, the Company restated revenue from $15.8 million to $8 million (a 97.5% overstatement) and net income from continuing operations of $1.1 million to a net loss from continuing operations of $3.4 million. For the second quarter of fiscal 1998, the Company restated revenue from $18 million to $12.4 million (a 45% overstatement) and net income of $1.7 million to a net loss of $1.7 million.
The other two defendants, Thomas Butler and Mark Folit, had previously settled with the Commission.