UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7464 / September 30, 1997 SECURITIES EXCHANGE ACT OF 1934 Release No. 39167 / September 30, 1997 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 972 / September 30, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9468 : ORDER INSTITUTING : PROCEEDINGS PURSUANT TO In the Matter of : SECTION 8A OF THE : SECURITIES ACT OF 1933 AND JOHN R. ALFSON, : 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 John R. Alfson 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, Alfson 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, Alfson consents to the entry of this Order Instituting Proceedings Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, Making Findings and Imposing a Cease-and- Desist Order. III. On the basis of this Order and Alfson's Offer of Settlement, the Commission makes the following findings:<(1)> A. Summary This matter involves violations of the antifraud, reporting, and record-keeping provisions of the federal securities laws at Laser Photonics, Inc. ("LPI"), a publicly held manufacturer of medical and scientific laser systems. In 1992 and 1993, certain officers and employees of LPI engaged in a scheme to defraud investors by causing LPI to inflate materially its revenues and profits by recording false sales on its books and by improperly recording future sales in current periods. The inflated revenues and profits were reported in LPI's Form 10-K for the year ended December 31, 1992, and a Form S-1 dated June 30, 1993, and caused the audited financial statements in these documents to be materially false and misleading. Respondent Alfson participated in the above activities, and his conduct was a significant factor in the creation of the materially false and misleading financial statements. During 1992 and 1993, Alfson was LPI's director of operations and, as such, he supervised LPI's manufacturing operations, including shipping and receiving. As director of operations, in 1992 and 1993, Alfson participated in decisions at LPI to record future sales improperly in current accounting periods, he altered and falsified documents that LPI used in production, quality control, shipping and accounting, and he directed other LPI employees to alter these same records. Alfson knew, or was reckless in not knowing, that as a result of these actions LPI would be reporting materially inflated revenues and profits.<(2)> B. Facts 1. Premature and Improper Recognition of Revenue and Concealing Improper Sales LPI disclosed in filings with the Commission that it recognized revenue when products shipped. In the words of a senior officer, however, LPI had a "flexible" year-end because the company "couldn't live by . . . clean cut-offs." LPI routinely recognized revenue on lasers before they were shipped. In connection with this practice, employees altered documents to conceal from LPI's auditors the premature recognition of revenue from sales. The records were altered because, as the senior <(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====== officer stated, "everything had to match," otherwise there would be "red flags popping up all over the place." For the year ended December 31, 1992, LPI prematurely and improperly recognized revenues of at least $664,000 for lasers which were shipped in 1993, out of total reported revenues for 1992 of $10,238,000.<(3)> As director of operations, Alfson regularly participated in meetings with LPI's officers during which the completion and shipment of lasers was discussed. On or around December 31, 1992, Alfson participated in such a meeting during which it was discussed that, due to slow sales, LPI would have difficulty making payroll and that LPI needed to show shipments for its bank line of credit. A senior officer asked Alfson what lasers Alfson could "get out" and Alfson responded with a list of lasers that were still waiting to be put through a quality assurance test called the Acceptance Test Procedure ("ATP").<(4)> At the meeting it was decided that Alfson and other employees would prepare documents called "picklists" for certain lasers on Alfson's list and that these picklists would be delivered to LPI's accounting department.<(5)> The picklists that were chosen to be prepared related to certain of the most expensive lasers then awaiting their quality tests. At some point following this meeting, Alfson prepared picklists for at least six customer laser orders. Five of the picklists Alfson prepared were typed, as opposed to the normal computer generated documents. Alfson and a senior officer directed subordinate employees to hand-type these picklists. The typed picklists all indicated a print date of "12/31/92." On these picklists, Alfson then entered unit serial numbers, a corresponding number next to "qty shipped," and the date "12/31/92," all in <(3)> Including false sales, LPI inflated its 1992 revenues by $1,756,000, an overstatement of 14.5 percent; LPI inflated its 1992 income to $173,000 when it should have reported a loss of at least $1,136,000, an overstatement of 657 percent. <(4)> The ATP was required by U.S. Food and Drug Administration regulations to prove that the laser met specifications. <(5)> The picklist was primarily a production tracking and control document. Under normal procedures, LPI's computer generated a five part, multi-colored picklist when an order was input; the document identified the customer, the laser ordered, and the delivery address. As the laser moved through LPI's planning, production, quality control, and shipping departments, employees would make hand-written notations on the picklist, such as the serial number, the date the laser passed certain quality control tests, shipping weight, and the date of shipment. LPI's accounting department obtained the picklist the day after shipment to generate an invoice. LPI's quality control, shipping and accounting departments each retained their own color coded copy of the picklist form. ======END OF PAGE 3====== his handwriting.<(6)> Also, on or after December 31, 1992, Alfson asked an employee in the shipping department to write the notation "12/31/92" on certain picklists to indicate that the laser had shipped on that day when, in fact, the laser was going to ship after that date. The employee refused, but several days later he discovered copies of several picklists which had been delivered to the shipping area and which had the date "12/31/92" written at the bottom. Some of these picklists were typed and had Alfson's handwriting on them, including Alfson's handwritten "12/31/92." Under LPI's normal procedures, the copies of the picklists retained by shipping constituted part of LPI's record as to when the items on the picklists physically shipped.<(7)> In connection with preparing the picklists, on December 31, 1992, Alfson directed a subordinate employee to close work orders and transfer into finished goods status the production records for six lasers. These production records, however, would not ordinarily have been transferred into finished goods status as of that date because two of the six lasers did not function according to specification and because none of the six lasers had successfully completed the ATP quality test. Nevertheless, the subordinate transferred the records into finished goods status.<(8)> After the picklists were prepared, Alfson gave them to a senior officer in accounting. According to Alfson, the officer was expecting the documents. LPI recorded sales and issued invoices as of December 31, 1992, based on the picklists Alfson and others had prepared. Alfson knew, however, that none of the lasers in question had actually shipped at that time. After the year-end, on January 5 and 6, 1993, Alfson directed a subordinate to close work orders and transfer into finished goods status as <(6)> The evidence as to the actual date the picklists were prepared is conflicting. Alfson testified all of the picklists were prepared by December 31, 1992. However, the fact that they were manually typed suggests that the picklists on which Alfson wrote "12/31/92" were prepared after year-end; one of the employees who typed the documents testified it "had to be [in] 1993" because another employee had placed the "true" shipping date on the original picklists, which LPI's senior officers "didn't want." <(7)> The shipping employee testified this conversation could have taken place on December 31, 1992, but if it did, both he and Alfson knew the lasers in question were not shipping that day. The employee also said that this was not the first time Alfson had asked him to enter false dates on documents. <(8)> LPI's quality control records indicate that at least two of these lasers did not complete the ATP until January 5, 1993. ======END OF PAGE 4====== of December 31, 1992, the production records of four additional lasers. The production records for these four lasers would not ordinarily have been transferred into finished goods status as of that date because none of the four lasers had been manufactured and certain parts for the lasers had yet to be ordered. The subordinate closed the work orders and LPI recorded sales as of December 31, 1992, for these four lasers too.<(9)> In early January 1993, Alfson met with LPI's president, chief financial officer, and a senior vice president and discussed the fact that none of the lasers for which picklists had been prepared had actually shipped on December 31, 1992. It was also stated that the lasers booked as sales as of December 31, 1992, would be counted as sales that year. It was decided that Alfson would continue working on getting the lasers shipped, the first of which did not actually leave LPI until January 5, 1993. 2. False Sales 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 the prototypes lost power with use and the model had never been released from LPI's engineering department and put into a regular manufacturing run. Nevertheless, as discussed above, two of the six lasers that Alfson directed a subordinate to transfer the production records into finished goods status on December 31, 1992, were purported "30 watt holmium" lasers that Alfson had identified to the subordinate by serial number. Invoices totaling over $160,000 were generated on December 31, 1992, billing two different customers for 30 watt holmium lasers LPI never put into production.<(10)> 3. LPI Files False and Misleading Forms 10-K and S-1 <(9)> When the employee questioned this order Alfson stated that this was being done in order for LPI to make payroll and to show shipments by year-end for LPI's bank line of credit. On January 12, 1993, this employee wrote a memorandum addressed to Alfson asking him to confirm in writing the instructions he gave on December 31, 1992, and January 5 and 6, 1993. The memorandum specifically identified the lasers in question by model and serial number. The employee said Alfson refused to sign the memorandum and told the employee not to "make waves." Alfson claimed that the employee never presented the memorandum to him. <(10)> LPI shipped both of these lasers on January 6, 1993, but neither was delivered to a customer. One laser went to an airport warehouse and returned to LPI shortly thereafter. The other was returned to LPI after the shipping instructions were cancelled and was placed in warranty repair status. Alfson stated in testimony that he was aware that the 30 watt model was still in development. According to a subordinate, Alfson acknowledged that he was aware that one of these lasers had been sent to a warehouse solely for the purpose of showing a shipment. ======END OF PAGE 5====== On May 28, 1993, LPI filed its Form 10-K for the year ended December 31, 1992. 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 materially false and misleading audited financial statements for the period ended December 31, 1992. The documents also contained false statements as to LPI's policy on the recognition of income and in the narrative discussion of the results of LPI's operations. C. Legal Analysis 1. Alfson 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 & 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 Associates 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). Alfson violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder because he participated in the scheme to defraud through the inflation of LPI's income and revenues and because his conduct was a significant factor leading to LPI's publication of materially false and misleading audited financial statements for the year ended December 31, 1992. These inflated revenues and income were included in LPI's Form 10-K for the period ended December 31, 1992, and in a Form S-1 dated June 30, 1993. Alfson's participation in the scheme included his attendance at year- end meetings and discussions with LPI's president, chief financial officer, and a senior vice president concerning LPI's poor sales, his preparation and delivery of picklists to a senior officer in LPI's accounting department for lasers which he knew had not shipped and had not been quality tested, his January 1993 instructions to close work orders as of ======END OF PAGE 6====== the 1992 year-end for lasers which he knew were not yet built, and his knowledge that certain sales booked as of December 31, 1992, would be counted as sales for that year even though he knew the lasers had not shipped that year. Alfson's participation also included his instructions to close work orders on two lasers which Alfson knew were only prototypes which lost power with use and had never been released from LPI's engineering department and put into a regular manufacturing run; this led to the reporting of two patently false sales on LPI's books for the 1992 year-end. By these actions, Alfson violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Alfson knew, or was reckless in not knowing, that LPI would be improperly recording sales prematurely and reporting false sales, and that LPI was hiding those improper actions from its auditors. Alfson knew, or was reckless in not knowing, that LPI and its officers and employees were engaged in an ongoing scheme to defraud investors by creating and publishing materially false and misleading financial statements. 2. Alfson 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 engaging in any transaction, practice or course of business that operates or would operate as a fraud upon a purchaser. Alfson's participation in the conduct described above was a significant factor leading to LPI's publication of materially false and misleading audited financial statements for the year ended December 31, 1992; these were incorporated in an LPI registration statement on Form S-1 dated June 30, 1993. Alfson thereby violated Section 17(a) of the Securities Act. 3. Alfson Violated the Record-Keeping Provisions of the Exchange Act Rule 13b2-1, promulgated under Section 13 of the Exchange Act, requires that no person shall, directly or indirectly, falsify or cause to be falsified, any book, record, or account of any issuer subject to the reporting requirements of the Exchange Act. Alfson violated Rule 13b2-1 by causing to be falsified LPI records used in production, quality control, shipping and accounting. IV. In view of the foregoing, the Commission has determined it is in the ======END OF PAGE 7====== public interest to accept Alfson'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 John R. Alfson cease and desist from committing any violations and any future violation of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5 and 13b2-1 thereunder. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 8======