UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7463 / September 30, 1997 SECURITIES EXCHANGE ACT OF 1934 Release No. 39166 / September 30, 1997 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 971 / September 30, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9467 : ORDER INSTITUTING : PROCEEDINGS PURSUANT TO In The Matter Of : SECTION 8A OF THE : SECURITIES ACT OF 1933 AND LASER PHOTONICS, INC., : SECTION 21C OF THE SECURITIES : EXCHANGE ACT OF 1934, MAKING Respondent : 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 Laser Photonics, Inc. ("LPI") 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, LPI 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, LPI 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)>: 1. Summary This matter involves violations of the antifraud, reporting, and record-keeping provisions of the federal securities laws by LPI. LPI was incorporated in 1980 and, during the relevant time period, its common stock was traded on NASDAQ.<(2)> LPI manufactures and markets medical and scientific laser systems. In 1989, 1990 and 1991 LPI reported net losses of ($978,330), ($2,507,100), and ($1,375,173) respectively. During 1992 and continuing until September 1993, LPI's management caused LPI to overstate materially its revenues and profits by reporting false sales and by inappropriately recording future sales in current periods. By these methods, LPI falsely inflated its reported 1992 year-end revenues by $1,756,000, from $8,482,000 to $10,238,000, an overstatement of 14.5%, and LPI falsely reported 1992 profits of $173,000 when it should have reported a loss of at least $1,136,000, an overstatement of 657%. These false revenues and profits caused LPI's Form 10-K for the year ended December 31, 1992, and a Form S-1 dated June 30, 1993, to be materially false and misleading. LPI's Forms 10-Q for the first and second quarters of 1993 were also materially false and misleading because they included additional false sales and because they incorporated LPI's 1992 year-end balance sheet, which the inflated revenues and profits caused to be materially false and misleading. LPI inflated its 1993 first quarter revenues by $533,000, or 24.7% of reported sales of $2,153,000, and revenues were inflated by $402,000, or 11.3% of reported sales of $3,543,000, for the six months ended June 30, 1993. LPI concealed the fraudulent and premature sales from its auditors by making misrepresentations concerning the shipment and sale of lasers, by forging, altering and concealing accounting, shipping and production records, and accounts receivable confirmation letters, and by persuading customers to sign false accounts receivable confirmation letters and "ship- in-place" request letters. The fraud was exposed in September 1993 when LPI's controller disclosed to LPI's directors, auditors and outside counsel the existence of certain false sales. This prompted the resignation of LPI's president and CEO and LPI's principal financial and accounting officer, and a public announcement by LPI that it had "discovered <(1)> The findings herein are made pursuant to Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding. <(2)> LPI has since undergone a reorganization in bankruptcy. Its stock currently trades over-the-counter on the Bulletin Board. ======END OF PAGE 2====== discrepancies in its financial statements" for the calendar year 1992 and for the first and second quarters of 1993 and that those financial statements "cannot be relied upon." 2. Facts a. False Sales LPI reported false revenues of at least $1,092,000 for the year ended December 31, 1992, and at least $402,000 for the two quarters ended June 30, 1993. LPI used several techniques to falsify its sales. One method was simply to report a laser unit as a sale that in actuality was on loan to a customer for evaluation purposes. Another technique was to issue invoices for lasers that were never shipped. Another approach used by LPI was to withhold the recording of credit memos for returns of lasers. Finally, at or near the end of the fiscal period, LPI shipped non- functional units and then caused the lasers to be returned to LPI before they reached the customers to whom they were addressed. The above methods required the collaboration of certain LPI senior officers and managers. i. Conversion of Evaluation Units to Sales In 1991 and 1992 LPI had a practice of loaning lasers to potential customers for use on an evaluation or demonstration basis. LPI accounted for these demonstration lasers by recording them as a fixed asset with a corresponding charge to earnings for depreciation if the units were held by the customer more than a year. As of December 31, 1992, however, LPI had falsely converted at least two of these transactions involving demonstration lasers to "sales" without the customers' knowledge or authorization. In July 1991, LPI provided a medical laser to a company in the southwest United States. On various occasions LPI executives and the company discussed the possible purchase of the laser, but the company never issued a purchase order for the laser and never authorized LPI to issue an invoice. Nevertheless, on March 13, 1992, LPI recorded a "sale" of this laser in the amount of $80,252. The company notified LPI in June 1992 that it was not purchasing the unit and was arranging to have the demonstration laser returned to LPI. Notwithstanding the notification from the company, LPI continued to report the March 13, 1992, transaction as a sale. In November 1991, LPI provided a medical laser to a hospital in central Florida for demonstration use by a doctor in an orthopedic surgery study. On various occasions LPI executives and the doctor discussed the possible purchase of the laser. As of December 1992 the hospital had not issued a purchase order for the laser and had not authorized LPI to issue an invoice. Nevertheless, on December 29, 1992, LPI recorded a "sale" of this laser to the hospital in the amount of $121,900. Instead of reversing the demonstration laser from fixed assets, LPI issued an invoice for a new medical laser for this false sale, thus double counting this single laser as both a "sale" and a "demonstration laser." ======END OF PAGE 3====== In March 1993, a company in the eastern United States agreed to accept a laser on a demonstration basis. Without the customer's authorization, LPI recorded a sale of $104,400 for this laser. Four months later, the customer returned the laser to LPI, but LPI did not reverse the purported sale until September 1993. ii. Shipment of Non-Functional Lasers As of December 1992, LPI was attempting to develop a 30 watt holmium laser, a more powerful version of a standard medical laser. LPI built prototypes of this model but they lost power with use and were never put into a regular manufacturing run. Nevertheless, on December 31, 1992, LPI accrued two purported "sales" of "30 watt holmium" lasers, one for $79,160 to a distributor in the western United States and the second for $84,688 to a distributor in the midwest. The first laser was picked up at LPI's facilities on January 6, 1993, by a commercial shipping company; the shipping instructions were then cancelled by LPI and the unit was returned to LPI and placed in "warranty repair" status. The second laser was shipped on January 6, 1993, to an airport warehouse in the midwest and then returned shortly thereafter to LPI; it was never ordered or received by the distributor. In February 1993 an LPI officer stated in a letter to the midwest distributor that the December 31, 1992, invoice was erroneous and would be properly credited to the customer's account. The invoice was not credited. iii. Failure to Credit Returned Goods and Billing Errors LPI had a stated policy during the relevant time period to credit customer accounts for returned goods and billing errors under appropriate circumstances. Nonetheless, included in LPI's 1992 financial statements were at least five significant sales of lasers which, by the time LPI filed its 1992 Form 10-K in May 1993, were the subject of customer returns or billing errors. In September 1992, a distributor returned to LPI a laser for which LPI had billed the distributor $81,480 on June 25, 1992. In addition, on June 30, 1992, LPI erroneously billed this same distributor $84,000 for an upgrade to an existing laser in the possession of the distributor. In a letter to the distributor dated February 1993, an LPI officer represented that the two June 1992 invoices would be credited. However, LPI did not credit the distributor's account and the financial statements for the year ended December 31, 1992, included the above two transactions as sales. In 1992, LPI agreed to develop a "pump" laser for use as a component in a larger scientific testing system being developed by a distributor. The distributor ordered two of the pump lasers, one for use by a university and the second for use by a U.S. government research laboratory. LPI billed the university directly for the first unit for $42,500 and LPI billed the distributor for the U.S. government laboratory unit for $42,500. The LPI pump lasers failed to meet contract specifications and in the fourth quarter of 1992 both users returned the pump lasers to LPI and advised LPI they would not pay for the lasers. Eventually LPI donated one ======END OF PAGE 4====== of the lasers to another university and LPI placed the second unit in "warranty repair" status. LPI did not reverse either sale and included the sale amounts in its year-end financial statements. In September 1992, LPI delivered a medical laser to a hospital on a demonstration basis. The laser had been ordered on behalf of the hospital by a distributor which was managed by a former LPI employee. Even though the hospital had not committed to purchase the laser, the distributor issued a purchase order to LPI for the laser and LPI in turn issued an invoice to the distributor for $67,125. The invoice was never paid. In December 1992, the distributor advised LPI that the hospital was not going to purchase the laser. The distributor forwarded the laser to other potential customers but eventually returned the laser to LPI in March 1993. LPI did not reverse this sale and included this sale in its 1992 year-end financial statements. iv. Lasers Which Were Never Shipped or Never Manufactured On September 30, 1992, LPI booked $84,000 of revenue from the sale of a medical laser to a distributor in the western United States. The laser was never shipped and the distributor never received an invoice for the laser. LPI included this sale in its third quarter and year-end financial statements. In 1991, LPI contracted to manufacture "ruby" medical lasers on behalf of an east coast company. In order to finance the costs to manufacture the lasers, LPI began a practice of invoicing the company before the lasers were manufactured. LPI then borrowed from a lending institution against the issued invoices. When the lasers were completed and shipped to the customers, LPI credited the first invoices and re-issued new invoices. The east coast company acquiesced in this practice. In at least five instances in 1992, however, LPI failed to reverse the initial invoices when completed lasers were shipped and invoices were re-issued. Thus, as of December 31, 1992, LPI had five invoices, totaling $325,000, outstanding to the east coast company for fictitious sales.<(3)> In March 1993, LPI received a cash payment of $260,000 from a customer as a full deposit for the manufacture and delivery of ten lasers. As of March 31, 1993, LPI had not manufactured any of the ten lasers, but LPI recorded a "sale" of $260,000 on March 31, 1993, for this transaction. As of June 30, 1993, LPI had manufactured and shipped five of the ten lasers <(3)> Due to technical problems with the ruby lasers the east coast company had in 1992 ceased to pay for the lasers which LPI had shipped and had claimed substantial warranty costs against LPI. In light of the customer's refusal to pay, LPI's auditors required LPI to reverse a substantial percentage of the outstanding invoices. However, even with this adjustment this customer's account was inflated because of the five fictitious transactions. ======END OF PAGE 5====== involved in this transaction, yet the "sale" of the full amount remained on its books. In March 1993, LPI had discussions with a company in the southern United States regarding the potential sale or demonstration use of a medical laser. At LPI's request, the southern company signed a purported "ship-in-place" letter, the language of which LPI had provided to the company.<(4)> As LPI knew, the ship-in-place letter was false, the southern company had never agreed to purchase a laser and no laser was ever shipped. Nevertheless, on March 31, 1993, LPI recorded a sale to the southern company of $83,360 for a medical laser. In addition, in the first quarter of 1993, LPI recorded a sale of $84,000 for a "30 watt holmium" laser to a distributor in the midwest. As described above, LPI was never able to produce a properly functioning "30 watt holmium" laser. In this case no laser ever shipped and the purported sale to the midwest distributor was an entirely fictitious transaction. b. Cut-Off Errors LPI disclosed in financial statements filed with the Commission that its policy was to recognize revenue when products were shipped from LPI. However, LPI improperly recognized revenues of at least $664,000 in the accounting period ended December 31, 1992, for lasers which were physically shipped to at least nine different companies in 1993.<(5)> In certain cases, the parts for the lasers were not yet ordered and the lasers not yet manufactured as of December 31, 1992, when the revenue for the sale of those lasers was recognized. In other cases certain medical lasers had not undergone the testing required by the U.S. Food and Drug Administration by December 31, 1992, when the revenue for the sale of those lasers was recognized. With respect to one overseas customer, a scientific laser failed its final test and inspection on December 31, 1992, yet the revenue for the sale of the laser was recognized on that day. These cut-off errors were the direct result of orders by LPI's senior executives. On December 31, 1992, senior executives of LPI directed <(4)> In limited circumstances, a seller may record a sale without shipping the product (i.e., ship-in-place) provided, in relevant part, that: 1) the buyer, not the seller, requests that the transaction be on a ship-in-place basis; 2) the buyer makes a fixed commitment to purchase the goods, preferably reflected in written documentation; and 3) the equipment is complete and ready for shipment at the time the request is made. See, Accounting and Auditing Enforcement Release Number 108, for other conditions to be met for ship-in-place sales. <(5)> Some LPI executives claimed that several of these sales were subject to "ship-in-place" arrangements. However, the evidence indicates that the criteria for "ship-in-place" revenue recognition were not met for any of the sales. ======END OF PAGE 6====== certain employees to alter or falsify documents associated with lasers for which revenue was recognized on December 31, 1992, but which were not shipped until 1993. These altered or falsified documents included "picklists," a tracking and control document, and booking journals. On January 5 and 6, 1993, senior executives of LPI directed certain LPI employees to alter or falsify additional documents in order to record revenues as of December 31, 1992, for additional lasers which did not ship until 1993. Senior executives of LPI directed other employees to falsely record on the books and records of LPI the revenues for these lasers as of December 31, 1992.<(6)> c. Misleading LPI's Auditors In order to prevent LPI's independent auditors from discovering the numerous fraudulent sale transactions, LPI, through certain of its executives and employees, made written and oral misrepresentations, altered, destroyed and concealed documents, and persuaded certain customers to sign false accounts receivable confirmation letters. Consequently, the auditing firm did not discover the false sales and cut- off errors on the books and records of LPI and at the conclusion of the audit rendered an unqualified opinion which stated that the 1992 consolidated financial statements of LPI were fairly stated and in conformity with Generally Accepted Accounting Principles ("GAAP"). In addition to the falsified pick lists and booking journals discussed above, to cover up sales made subsequent to LPI's year end, senior executives of LPI directed the systematic falsification of shipping records. This was done, according to a former officer of LPI, so as not to leave any "red flags" which would alert LPI's auditors. By these methods LPI concealed from its auditors sales made subsequent to year end that were included in the 1992 financial statements. In a test of LPI's internal controls for sales transactions, the auditors had selected by chance one of the fictitious sales for review. The auditors requested from LPI all original shipping documents for the sale. In order to provide the auditors with documents to show that the sale was properly recorded, an LPI officer obtained a blank copy of a bill of lading and forged the document so that it would appear to the auditors that the laser had shipped on September 30, 1992, the day LPI accrued the sale. <(6)> LPI employees testified that LPI senior officers routinely "held open" accounting periods and included sales for lasers which physically shipped after the accounting period ended. ======END OF PAGE 7====== A significant element of any audit is the confirmation of financial data with independent third parties such as customers.<(7)> LPI's auditors confirmed with customers approximately 80% of the dollar value of LPI's outstanding receivables as of December 31, 1992. However, LPI's senior executives persuaded at least four customers to sign false accounts receivable confirmation letters. In addition, certain customers forwarded their confirmation letters through LPI. At least one of these letters was altered before being given to LPI's auditors and at least one other confirmation letter was never delivered to LPI's auditors.<(8)> d. LPI Files False and Misleading Forms 10-K, S-1 and 10-Q On May 28, 1993, LPI filed its Form 10-K for the year ended December 31, 1992. On June 1, 1993, LPI filed its Form 10-Q for the quarter ended March 31, 1993. On August 6, 1993, LPI filed its Form 10-Q for the quarter ended June 30, 1993. On June 25, 1993, LPI filed an amendment to Form S-1 (which had been filed on November 6, 1992); this amendment became effective on June 30, 1993. The Form 10-K and the amendment to the Form S-1 contained the materially false and misleading audited financial statements for the period ended December 31, 1992, and they also contained false statements as to LPI's policy on the recognition of income and in the narrative discussion of the results of operations. The Forms 10-Q contained misleading financial statements for interim reporting periods and the materially false and misleading 1992 balance sheet for LPI. 3. Legal Analysis a. LPI 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 material fact or from omitting to state material facts necessary in order to make statements made, in 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. <(7)> As set forth in Generally Accepted Auditing Standards, an auditor is required to confirm selected accounts receivable balances with individual customers. This provides the auditor with independent evidence that the receivable exists and is for the amount stated on the books and records of the audit client. <(8)> In the case of confirmation letters forwarded through LPI, LPI's auditors undertook "alternate procedures" and checked underlying documentation or telephoned customers. However, due to the falsification of documents discussed above and the collusion of certain customers, these procedures did not bring to light the misrepresentations in certain confirmation letters. ======END OF PAGE 8====== 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 & 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, 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). The failure to disclose information required in Management's Discussion and Analysis may also be material. See In the Matter of Caterpillar Inc., Admin. Proc. File No. 3-7692, AAER No. 363 (March 31, 1992). LPI violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder because it filed with the Commission a Form S-1 amendment on June 25, 1993, a Form 10-K for the year ended December 31, 1992, and Forms 10-Q for the quarters ended March 31, 1993, and June 30, 1993, which were materially false and misleading. In all of these public filings, LPI's revenues and profits were materially inflated as the result of including false sales and making intentional cut-off errors in contravention of GAAP. The Financial Accounting Standards Board Statement of Financial Accounting Concepts Statement No. 5 states that "[r]evenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash." The earning process is complete "when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." Members of LPI's then existing senior management knew that LPI's audited financial statements for the year ended December 31, 1992, were materially false and misleading because they included in year-end sales (1) laser units for which there was no exchange and (2) laser units that were not yet completely manufactured. As they knew, this treatment created the illusion that LPI had become a profitable enterprise when in fact it had not. b. LPI Violated the Antifraud Provisions of the Securities Act Section 17(a)(1) of the Securities Act prohibits a person, in the offer or sale of any securities, from making untrue statements of material fact or from omitting to state material facts. 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 untrue statements of material fact or omissions of material fact. Section 17(a)(3) prohibits a person, in the offer or sale of any securities, from engaging in any transaction, practice ======END OF PAGE 9====== or course of business that operates or would operate as a fraud upon a purchaser. In June of 1993, LPI filed with the Commission an amendment to a registration statement on Form S-1 which incorporated LPI's materially false and misleading 1992 financial statements, and LPI thereby violated Section 17(a) of the Securities Act. c. LPI Violated the Reporting and Record-Keeping Provisions of the Exchange Act Section 13(a) of the Exchange Act requires issuers with securities 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. Rules 13a-1 and 13a-13 require issuers to file annual and quarterly reports, respectively. 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). LPI violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder by filing annual and quarterly reports for its fiscal year ended December 31, 1992, and its quarters ended March 31, 1993, and June 30, 1993, that contained materially false and misleading financial statements. 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. LPI violated Section 13(b)(2)(A) of the Exchange Act by making entries in its books and records which reflected false sales and cut-off errors. Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles. LPI violated Section 13(b)(2)(B) of the Exchange Act by failing to devise and maintain a system of internal accounting controls sufficient to prevent the recording of false sales and cut-off errors in contravention of GAAP. IV. In view of the foregoing, the Commission has determined it is in the public interest to accept LPI's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section ======END OF PAGE 10====== 21C of the Exchange Act, that Laser Photonics, Inc. cease and desist from committing any violations and any future violation of Section 17(a) of the Securities Act of 1933, and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 10b-5, 13a-1, 13a-13 and 12b-20 thereunder. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 11======