UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7426 / June 25, 1997 SECURITIES EXCHANGE ACT OF 1934 Release No. 38774 / June 25, 1997 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 930 / June 25, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9341 In the Matter of SPECTRUM INFORMATION TECHNOLOGIES, INCORPORATED, Respondent ORDER INSTITUTING PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933 AND SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS AND IMPOSING A CEASE-AND-DESIST ORDER I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted against Spectrum Information Technologies, Inc. ("Spectrum") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"). II. In anticipation of the institution of these administrative proceedings, Spectrum has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purposes 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, Spectrum consents to the entry of this Order Instituting Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order. III. On the basis of this Order and Respondent's Offer of Settlement, the Commission makes the following findings<(1)>: A. Summary Spectrum was incorporated in 1984 and became a publicly held company in 1991; its common stock traded in the NASDAQ system. From its inception in 1984 through its fiscal year ended March 31, 1993, Spectrum operated at a loss and experienced operating cash flow deficits. Spectrum was engaged, through its subsidiaries, in various aspects of the computer industry during 1992 and 1993. During the course of its operations, Spectrum obtained patents that relate to methods to transmit data over public cellular telephone networks. This matter involves violations of the registration, antifraud, reporting and record-keeping provisions of the federal securities laws during 1992 and 1993.<(2)> In 1992, Spectrum effected an unregistered distribution of its common stock by granting options (ostensibly pursuant to its employee stock option plan) in the name of certain employees and a consultant while maintaining control over the exercise of those options, the sale of the underlying stock, and the use of the proceeds from such sales. Between May and October of 1993, Spectrum entered into a series of transactions to create the illusion that a license of its technology was worth "seven figures." Spectrum persuaded a series of companies to agree to pay Spectrum large fees to license its patented technology by promising those same parties payments that would substantially offset their fees. Spectrum issued press releases and filed quarterly reports with the Commission that were materially false and misleading in that they greatly inflated the economic value of these licensing transactions. The quarterly reports also included financial statements that failed to comply with Generally Accepted Accounting Principles ("GAAP") because they materially overstated Spectrum's revenue and income by using an accounting method that recognized substantial revenue by favoring the form of Spectrum's licensing transactions over their substance. As a result of this improper revenue recognition, Spectrum was able to falsely report profits instead of losses in its filings with the Commission for two consecutive quarters. Spectrum also issued press releases touting its profits in those quarters when Spectrum actually sustained losses in excess of $2 million. The release <(1)> The findings herein are made pursuant to Spectrum's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding. <(2)> On January 1, 1995, Spectrum elected a new President, Chief Executive Officer and Chairman, and a new Board of Directors. The findings herein relate to actions and events that occurred before the appointment of Spectrum's current CEO and Board of Directors, who have cooperated in the staff's investigation. ======END OF PAGE 2====== announcing profits for Spectrum's quarter ended September 30, 1993 further aggravated the falsity of Spectrum's financial results by touting the untrue fact that those profits marked the first time in the company's history that it had two consecutive profitable quarters. B. Facts 1. Spectrum Sold Unregistered Shares of Its Common Stock to Raise Needed Cash For the Company During 1992, Spectrum granted immediately exercisable options to its employees pursuant to its 1991 Stock Option Plan ("Plan") to bring additional money to the company in form of the exercise price paid by the employees.<(3)> Some of these grants, however, were made only nominally to Spectrum employees. In these instances, Spectrum granted large numbers of options in the name of employees while controlling the exercise of those options, the sale of the underlying stock, and the proceeds from such sales. Specifically, in August of 1992, Spectrum arranged for one of its employees (who was also the brother-in-law of Spectrum's then-Chief Executive Officer) to receive a large option grant, purportedly as an employee bonus. Although the options were issued in the employee's name, Spectrum controlled virtually all aspects of the exercise of those options and the sale of the underlying stock. Brokerage statements for the account through which the employee's options were exercised were sent directly to Spectrum's headquarters, located outside of the state where the employee lived and worked. Spectrum also arranged for the bulk of the proceeds from the sales of the underlying stock to be deposited into Spectrum's own bank accounts. Also in August of 1992, Spectrum issued options (purportedly under the Plan) in the name of its public relations consultant, then directed the consultant to use the proceeds from sale of shares underlying the options to pay outstanding debts which had been incurred directly by Spectrum. These debts were not associated with any services performed or contracted by the consultant. Further, Spectrum granted a large amount of options in the name of a newly-hired employee in August of 1992, then arranged for a broker to fund the exercise of those options and sell the underlying stock (which had been issued by Spectrum in the name of the broker's firm). At Spectrum's direction, the broker split the sale proceeds with the brother of Spectrum's then-Chairman of the Board. In December of 1992, Spectrum solicited an employee (who had already announced his intention to leave the company) to accept and exercise a large option grant. When the employee expressed concern about his potential tax liability from such a transaction, the company directed him to accept the option grant, exercise the options, then sell the underlying common stock at a price equal to the exercise price so there would be no <(3)> Shares issued pursuant to the Plan were registered by Spectrum on Form S-8 in January of 1992. ======END OF PAGE 3====== tax consequences to the employee. The employee followed Spectrum's instructions, generating no profit for himself, but providing Spectrum with additional cash for its operations in the form of the option exercise price. Spectrum was able to raise over one and one-half million dollars as a result of the option exercise prices it received in connection with the transactions described above. 2. Spectrum Offset Fees Paid By Licensees With Advertising Payments to Licensees In late 1992, Spectrum decided that it would seek "seven figure" cash licensing fees from companies it felt were using its patented technology without permission. Spectrum contacted several of these companies and began negotiating with potential licensees on this basis. In May of 1993, Spectrum signed an agreement to license its technology to a modem manufacturer (hereinafter referred to as "Company A"). When Spectrum proposed a "seven figure" licensing fee, Company A refused to pay a fee of that magnitude. Instead of agreeing to a smaller licensing fee that Company A would be willing to pay, Spectrum proposed a deal structure that would create the appearance that Spectrum had received a "seven figure" licensing fee while imposing no burden on the licensee to pay such an amount. The parties signed a licensing agreement requiring Company A to pay Spectrum royalties, an immediate cash payment of $250,000, and additional payments in quarterly installments totaling $1,250,000 over a fifteen month period. The parties also signed a separate contract, entitled "Advertising Agreement," requiring Spectrum to pay Company A $1,250,000 in quarterly installments due on the same date and in the same amount as the fee due from Company A under the licensing agreement.<(4)> Spectrum entered into agreements with Company B and Company C, in July and October of 1993, respectively. Both of these transactions were structured in a manner similar to Spectrum's deal with Company A, again the result of the refusal by both Company B and Company C to pay "seven figure" fees. Company B agreed to pay Spectrum a licensing fee consisting of an immediate cash payment of $5,000, $45,000 upon the completion by Spectrum of certain engineering efforts, and quarterly installments totalling $1,500,000. Spectrum agreed, under a separate contract (again labeled "Advertising Agreement"), to pay Company B $1,500,000 in quarterly <(4)> Also in May of 1993, Spectrum attempted to obtain a "seven figure" licensing fee from a major telecommunications company. When Spectrum suggested a licensing fee of that size, its proposal was rejected. The parties ultimately agreed that the licensee would pay Spectrum a $150,000 licensing fee, and royalties based on the number of units sold by that company containing technology covered by Spectrum's patents. ======END OF PAGE 4====== installments due in the same amount and on the same date as the quarterly payments due from Company B under the licensing agreement. Similarly, Spectrum and Company C executed a licensing agreement requiring Company C to pay Spectrum $106,250 upon the signing of the licensing agreement (comprised of a $100,000 licensing fee payment and a payment of $6,250 for Spectrum's engineering efforts), a fee of $6,250 upon the completion of certain engineering efforts, $150,000 upon the delivery or sale by Company C of the first modem incorporating the licensed technology, and quarterly payments totaling $1,250,000. Spectrum then agreed, pursuant to a separate advertising agreement, to pay Company C $1,250,000 in quarterly payments due on the same date and in the same amount as Company C's installment payments of the licensing fee.<(5)> Both the contractual terms of these transactions and the course of dealing between Spectrum and Companies A, B and C provide evidence that the advertising aspect of each of these transactions was merely a vehicle by which Spectrum could offset the licensing fees it claimed to be receiving from these parties. For example, Spectrum negotiators sent deal proposals to Company B that referred to the licensing and advertising fee as offsetting, and also used the net amount of the licensing and advertising fee when referring to the licensing fee that was under negotiation. In addition, Company B insisted on a provision in the advertising agreement requiring that Spectrum continue to make payments to Company B even if the agreement, for any reason, was terminated.<(6)> The advertising agreements signed by Companies A and C also reflected the offsetting nature of the licensing transactions by including language protecting Spectrum from having to pay the advertising fee in the event the licensees stopped paying the licensing fee. Further, Companies A and C insisted that Spectrum make each payment of the advertising fee before they would release their licensing fee payment.<(7)> In addition, neither Spectrum nor these licensees took any steps to determine the value of the advertising to be performed by the licensees and no attempts were made by either Spectrum or the licensees to independently negotiate the amount of the advertising fee. Companies B and C never even considered the cost they would incur in <(5)> A summary of the payment provisions of Spectrum's transactions with Companies A, B and C is attached hereto as Appendix 1. <(6)> The advertising agreement provided, however, that in the event of a breach of that agreement by Company B, Spectrum could be relieved of its obligation to make further payments of the advertising fee. <(7)> Company C did not make installment payments of the licensing fee to Spectrum because it had not received any advertising fee payments from Spectrum. On the first two occasions when payments of the licensing fee became due from Company A, Company A had to remind Spectrum to make its advertising fee payment so that Company A could release its matching licensing fee payment. ======END OF PAGE 5====== performing the advertising Spectrum contracted to receive. In fact, Company C observed that the advertising fee was unrelated to advertising since Spectrum was paying the fee months before Company C would even sell any products containing the promotional information Spectrum requested. 3. Spectrum Agreed to Return Royalties to a Licensee Up to the Amount of the Licensing Fee In October of 1993, Spectrum entered into a licensing transaction with Company D that did not contain the offsetting payment structure of the transactions described above. In this licensing transaction, Company D agreed to pay Spectrum royalties on various products sold or delivered by Company D, as well as a licensing fee of $2,500,000, payable in nine quarterly installments. The agreement also provided, among other things, that Company D customers could buy certain of these products directly from Spectrum. The agreement required Spectrum to pay Company D a fee (described as compensation for certain marketing efforts), in quarterly installments over the same period of time as the licensing fee, in an amount equal to fifty percent of the royalties Spectrum received from Company D's sales of products.<(8)> This fee was not to exceed, in any quarter or in total, the $2,500,000 fee paid by Company D; provided, however, that if the fee remitted to Company D did not total $2,500,000 by the time the ninth payment was made, Spectrum's obligation to make such quarterly payments was to continue over the life of the agreement until $2,500,000 had been remitted to Company D. Although there was no guarantee in this instance that Spectrum would repay to Company D the $2.5 million licensing fee, a representative from Company D (who participated in the negotiations) believed that the entire fee would be repaid. 4. Spectrum Filed a False and Misleading Form 10-Q for its Quarter Ended June 30, 1993 Spectrum's report for its quarter ended June 30, 1993 included financial statements that improperly recognized as revenue the licensing fees set forth in the licensing agreements it entered into with Companies A and B. As discussed above, these licensing transactions involved the <(8)> The amount to be remitted to Company D by Spectrum included, for the products Company D customers purchased directly from Spectrum, fifty percent of the royalties Company D would have been required to pay if its customers had purchased the products from Company D; and fifty percent of the royalties Company D paid to Spectrum for sales made by Company D. Spectrum, however, was not required under the agreement to remit any portion of a one cent royalty it was to receive from Company D based on sales by Company D of one of the products covered by the licensing agreement. ======END OF PAGE 6====== upfront payment by the licensees of specified amounts, followed by the equal exchange of periodic payments between the licensees and Spectrum. Instead of recording the net difference between the amounts Spectrum received and the amounts Spectrum paid to Companies A and B, Spectrum claimed as earnings the total amount of all fees it was to receive under the licensing agreements while deferring the expense associated with the periodic payments it would make to the licensees under the advertising agreements. Specifically, Spectrum recorded as revenue from Companies A and B the total amount it was to receive under the licensing agreements, including the quarterly installment payments. But instead of recording the total amount of its obligation to make offsetting payments to Companies A and B as an expense in that quarter, Spectrum recorded the obligation as an asset, in the form of a prepaid expense, to be amortized to current expense at the same rate as it received royalties from the licensees' sales of units pursuant to the licensing agreements.<(9)> This accounting treatment was not in accordance with GAAP because it favored the form of the transactions (i.e., documents purporting to reflect two separate agreements with independent substance and value) over their true substance (i.e., documents creating an equal exchange of money with no real intent to confer a benefit to Spectrum of the amount set forth in the licensing agreements). As a result of its use of this improper accounting, Spectrum was able to claim net income for that quarter of $410,244 instead of net losses of $2,389,756. Moreover, even if the agreements had substance, the recognition of the total licensing fee due from Company B would still have been improper. Spectrum's former management has contended that it did not physically exchange payments with Company B when such payments became due because Spectrum and Company B interpreted their agreement not to require the payment of any additional monies, including the installment portion of the licensing and advertising fees, until the engineering tasks required by the licensing agreement were completed.<(10)> If this were the case, the <(9)> For example, Spectrum's licensing agreement with Company B required Company B to pay (i) $5,000 on July 15, 1993; (ii) $45,000 upon the completion by Spectrum of certain engineering efforts; (iii) $1.5 million in $250,000 quarterly increments starting on August 30, 1993; and (iv) royalties on specified items. Spectrum's advertising agreement with Company B required Spectrum to pay $1.5 million in $250,000 quarterly increments starting on August 30, 1993. Spectrum immediately recognized as revenue from that license agreement $1,550,000. Although Spectrum was obligated to pay Company B an advertising fee of $1.5 million, Spectrum recognized no expense from its obligation because Spectrum received no royalties under the licensing agreement as of that date. <(10)> At least fourteen months after Spectrum reported revenues from this licensing contract, Spectrum still had not (continued...) ======END OF PAGE 7====== recognition by Spectrum of the total licensing fee due from Company B was still improper because under GAAP, the contingent amounts due under the contract should not have been recognized by Spectrum until the outstanding contingency had been satisfied. Spectrum's Form 10-Q for its quarter ended June 30, 1993 contained numerous other material misstatements concerning the licensing transactions reflected therein. Spectrum reflected in this Form 10-Q its licensing transaction with Company B, which was not actually signed until after the end of the quarter. Yet Spectrum falsely described the agreement in the Form 10-Q as "signed" and recognized revenue from the transaction. This recognition was improper, as GAAP precludes the recognition of revenue from contracts in periods in which material provisions of the contract are still being negotiated by the parties. Documents indicate that substantive provisions of Spectrum's transaction with Company B were still under negotiation after the end of the quarter. In addition, the representative from Company B who was involved in the negotiations testified that no agreement had been reached until the final agreement was signed. In addition to the various improper accounting practices applied to the financial statements, Spectrum's Form 10-Q for its quarter ended June 30, 1993 contained inadequate disclosures concerning the licensing transactions reflected in that quarter. This Form 10-Q disclosed that Spectrum recognized as revenue a total of $3.2 million from licensing agreements. However, Spectrum did not disclose, either in the notes to its financial statements or in the Management's Discussion and Analysis ("MD&A"), that these licensing transactions would have little effect on Spectrum's cash flows or actual earnings since the funds it was receiving under the licensing agreements were being exchanged simultaneously for funds it was paying out under the advertising agreements.<(11)> <(10)>(...continued) completed the engineering tasks and, as a result, only received a total of $5,000 from Company B as of that point in time. <(11)> Spectrum drafted two separate notes to the financial statements included in its June 30, 1993 Form 10-Q that effectively obscured the substance of these transactions. Note 10 to the financial statements indicated the total amount of fees to be paid to Spectrum under the licensing agreements, and explained that royalties, and in the case of the agreement with the telecommunications company, a potential equity arrangement, were also part of the licensing agreements. Note 11 stated that two of the licensing agreements were accompanied by mutual advertising agreements under which the Spectrum would make payments to the licensees. Instead of disclosing the offsetting relationship between the advertising and licensing agreements, or the fact that payments would be exchanged under those agreements, the note mechanically recited (continued...) ======END OF PAGE 8====== Specifically, Spectrum did not disclose that it was only paid $405,000 in that quarter, and that of the remaining amount, $1,545,000 would not be received until Spectrum completed certain engineering tasks it was required to perform under its licensing agreement with Company B, and further, that $1,250,000 of that amount would be received in quarterly installments over a fourteen month period. Moreover, the Form 10-Q did not disclose Spectrum's arrangement with Companies A and B to exchange equal amounts on the same dates in connection with their respective obligations under the licensing and advertising agreements. 5. Spectrum Filed a False and Misleading Form 10-Q for its Quarter Ended September 30, 1993 Spectrum reflected in its Form 10-Q for its quarter ended September 30, 1993 its transactions with Companies C and D. Spectrum's transaction with Company C involved offsetting licensing and advertising agreements, effecting an exchange of money that netted only a small amount of cash for Spectrum. As with its transactions with Companies A and B, reported in the preceding quarter, Spectrum accounted for the transaction in a manner inconsistent with GAAP. Again, Spectrum recognized as revenue the total amount stated in its licensing agreement with Company C while deferring the associated expenses resulting from the companion advertising agreement Spectrum entered into with that same company. Spectrum also recognized an incorrect amount of revenue from its licensing agreement with Company D. The licensing fee to be received by Spectrum from Company D was in substance an advance or guarantee by the licensee of the royalties it expected to pay to use the license. Under GAAP, this royalty guarantee or advance should have been recognized when earned -- for example, when the units were sold. Instead, Spectrum recognized the full amount of the $2,500,000 fee in its quarter ended September 30, 1993. The accounting treatment Spectrum employed for these two licensing transactions enabled Spectrum to claim net income in that quarter of $646,374 instead of net losses of $2,925,029. Spectrum's licensing transactions with both Companies C and D were unsigned as of the end of the quarter because the agreements were still under negotiation, yet they were included in the quarter's financial <(11)>(...continued) the results of Spectrum's improper accounting treatment: "The accompanying balance sheet . . . includes $883,333 in other current assets and $1,866,667 in other assets, which reflect the anticipated benefits to be derived from the joint advertising agreements . . . which will be amortized in future periods. At June 30, 1993, $2,000,000 and $750,000, respectively, are included in current liabilities and other liabilities, to reflect the payments which the Company will make to [the licensees] in connection with these mutual advertising agreements." ======END OF PAGE 9====== statements contrary to GAAP.<(12)> Further, Spectrum's licensing agreement with Company C required Company C to pay a specified amount upon Spectrum's completion of certain engineering efforts. Spectrum included this amount in its financial statements as revenue even though GAAP would permit the recognition of this amount only after Spectrum performed the engineering tasks and the contingencies were resolved. In the notes to the financial statements included in this Form 10-Q, Spectrum described $3,792,000 in revenue from two licensing agreements; Spectrum falsely stated that these agreements were "signed" during the quarter when, in fact, the agreements were not signed until after the end of that period. In addition, the Form 10-Q did not disclose in the notes to the financial statements or in the MD&A that Spectrum's licensing transaction with Company C would have almost no effect on cash flow since Spectrum was receiving $1.5 million from licensing fees and simultaneously returning $1.25 million in the form of advertising compensation. As it had done in its June 30, 1993 Form 10-Q, Spectrum instead used a technical accounting description in the notes to the financial statements that obscured the true substance of the transactions. Further, the Form 10-Q did not disclose that Spectrum was required to remit to Company D an amount equal to fifty percent of the royalties Spectrum received from Company D's sales of products (excluding the one cent royalty paid on one specific product) and -- for the products Company D customers purchased directly from Spectrum -- fifty percent of the royalties Company D would have been required to pay if its customers had purchased the products directly from Company D. 6. Spectrum Issued False and Misleading Press Releases Spectrum issued press releases concerning each of the licensing transactions described above. Spectrum's press releases announcing its licensing arrangements with Companies A and B disclosed that it was receiving fees and royalties from these licensees (in the case of Company A, Spectrum's release even specified that Spectrum was receiving $1,500,000 as a licensing fee), but failed to mention that Spectrum was paying fees to those same entities in amounts almost equal to the fees it was receiving. In the case of its transaction with Company D, Spectrum's press release announced that it would be receiving fees and royalties, but did not disclose its obligation to repay the licensee a share of the royalties it received up to the amount of the licensing fee paid by the licensee. Spectrum also issued press releases announcing its financial results for its quarters ended June 30, 1993 and September 30, 1993. Spectrum's release for its quarter ended June 30, 1993 falsely announced net profits of $410,244, when Spectrum actually sustained a loss in that quarter of over $2 million. This release described an increase in net income "due <(12)> Representatives from Companies C and D who were involved in the negotiations with Spectrum confirmed that they had reached no agreement with Spectrum as of the end of that quarter. ======END OF PAGE 10====== primarily to the receipt of fees from new licensees" and went on to state that Spectrum expected to continue to receive such fees as it signed up new licensees. However, this release did not disclose that Spectrum was offsetting the bulk of the fees it received by making payments to the licensees. Nor did it describe the accounting method used in that quarter that allowed Spectrum to report net profits instead of net losses. In November of 1993, Spectrum falsely announced a net profit of $646,374 for its second quarter ended September 30, 1993, when it experienced net losses in excess of $2.9 million for that period. This release touted the untrue fact that for the first time in the company's history it had two consecutive profitable quarters. This release again attributed the company's increase in net income to the receipt of fees from new licensees and reiterated the company's expectation of additional fees as new licensees are signed up. Again, this release failed to disclose the payments Spectrum promised to make to the licensees, or the accounting method it applied in that quarter. C. Legal Analysis 1. Spectrum Violated the Registration Provisions of the Securities Act Section 5(a) of the Securities Act provides that unless a registration statement is in effect as to the security, it is unlawful for any person, directly or indirectly, to sell the security through interstate commerce or the mails. Section 5(c) similarly prohibits the offer to sell a security unless a registration statement has been filed. Spectrum violated Sections 5(a) and 5(c) of the Securities Act by selling its common stock directly into the market (using employees and a consultant as nominees) without having a registration statement in effect as to those securities. Spectrum's registration of common stock on Form S-8 does not apply to the transactions at issue because that registration statement only covered sales of stock to "employees," as that term is defined in the Instructions to Form S-8. In the factual circumstances described herein, Spectrum made no transactions with "employees"; Spectrum only used their names to disguise its sales of common stock into the market. 2. Spectrum Violated the Antifraud Provisions of the Exchange Act Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit a person, in connection with the purchase or sale of a security, from making an untrue statement of a material fact or from omitting to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. To violate Section 10(b) and Rule 10b-5, a person must act with scienter, Aaron v. SEC, 446 U.S. 680, 695 (1980), which the Supreme Court has defined as "a mental state embracing intent to deceive, manipulate or defraud," Ernst & ======END OF PAGE 11====== Ernst v. Hochfelder, 425 U.S. 185, 193 n. 12 (1976). Reckless or willful disregard of the truth satisfies the scienter requirement. E.g., IIT v. Cornfeld, 619 F.2d 909, 923 (2d Cir. 1980). A fact is material if there is a substantial likelihood that a reasonable investor would consider the information to be important. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). Among the facts that may be considered material is the misrepresentation of a company's earnings. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833,849 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969); Alna Capital Assocs. v. Wagner, 532 F. Supp. 591, 599 (S.D. Fla. 1982). Consistent therewith, the improper recognition of revenue in contravention of GAAP may be considered material. See Fine v. American Solar King Corp., 919 F.2d 290, 297, 300-301 (5th Cir. 1990). Spectrum violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder because it filed with the Commission Forms 10-Q for quarters ended June 30, 1993 and September 30, 1993 which were materially false and misleading. The Forms 10-Q misrepresented the company's earnings for those quarters as the result of its improper recognition of revenues from its licensing transactions in contravention of GAAP. Spectrum also failed to adequately disclose material information concerning the substance of its licensing transactions and the effect of those transactions on its cash flows. Spectrum also violated Section 10(b) by issuing materially false and misleading press releases concerning its earnings and the licensing transactions it had negotiated. Certain former members of Spectrum management knew or were reckless in not knowing that the accounting treatment applied to these transactions was false and misleading since it allowed Spectrum to recognize an amount of revenue from licensing fees much greater than the fees that were actually earned. As they knew or were reckless in not knowing, this treatment created the illusion that Spectrum had become a profitable enterprise when in fact it had not. Moreover, certain former officers at Spectrum knew or were reckless in not knowing that the Forms 10-Q at issue did not adequately describe the terms of the company's licensing transactions. These officers also knew or were reckless in not knowing that the company recognized revenues from contracts before they were signed, recognized engineering fees that were not yet earned, and recognized a royalty advance or guarantee as revenue, all in contravention of GAAP. 3. Spectrum Violated the Antifraud Provisions of the Securities Act Similar to Section 10(b), Section 17(a)(1) of the Securities Act prohibits a person, in the offer or sale of any securities, from making an untrue statement of a material fact or from omitting to state a material fact. See, e.g., U.S. v. Naftalin, 441 U.S. 768 (1979). In addition, Section 17(a)(2) of the Securities Act prohibits a person, in the offer or sale of any securities, from obtaining money by means of an untrue statement of a material fact or an omission of a material fact. Section 17(a)(3) prohibits a person, in the offer or sale of any securities, from ======END OF PAGE 12====== engaging in any transaction, practice or course of business that operates or would operate as a fraud upon a purchaser. In December of 1993, Spectrum filed with the Commission a registration statement on Form S-8 which incorporated by reference the false and misleading Forms 10-Q Spectrum filed for its quarters ended June 30, 1993 and September 30, 1993, thereby violating Section 17(a) of the Securities Act. 4. Spectrum Violated the Reporting and Record-Keeping Provisions of the Exchange Act Section 13(a) of the Exchange Act requires issuers whose securities are registered pursuant to Section 12 of the Exchange Act to file such information and documents as the Commission shall prescribe by its rules and regulations. Rule 13a-13 requires issuers to file annual and quarterly reports. Rule 12b-20 requires that periodic reports contain such further information as is necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. The filing of a periodic report containing materially false or misleading information constitutes a violation of these regulations. E.g., SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978); SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975). Spectrum violated Section 13(a) of the Exchange Act and Rules 13a-13 and 12b-20 thereunder by filing quarterly reports for its quarters ended June 30, 1993 and September 30, 1993 that contained materially false and misleading financial statements and disclosures concerning licensing transactions it reflected in those quarters. Section 13(b)(2)(A) of the Exchange Act requires issuers to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer. Spectrum violated Section 13(b)(2)(A) of the Exchange Act by making entries in its books and records recognizing as revenue fees from licensing agreements while deferring the associated expense from the advertising agreements intended to offset the licensing fees, by improperly recognizing as revenue a royalty advance or guarantee paid by one of the licensees, by prematurely recognizing revenue from three licensing agreements before the agreements were signed, and by recognizing as revenue amounts due from certain licensees that were contingent on future engineering efforts to be performed by Spectrum. IV. In view of the foregoing, the Commission has determined it is in the public interest to accept Spectrum's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Spectrum cease and desist from committing any violations and any future violation of Sections 5(a), 5(c) and 17(a) of the ======END OF PAGE 13====== Securities Act, and Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 13a-13 and 12b-20 thereunder. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 14======