UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 34-36855 / February 16, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 760 / February 16, 1996 ADMINISTRATIVE PROCEEDING File No. 3-8920 __________________________ : In the Matter of : : ORDER MAKING FINDINGS AND AMERICAN AIRCRAFT : IMPOSING A CEASE ANDDESIST CORPORATION : ORDER BY DEFAULT : _________________________: The Division of Enforcement ("Division") has filed a motion for default in this matter. In support of its motion, the Division states that the Order Instituting Public Administrative And Cease And Desist Proceedings And Notice Of Hearing Pursuant To Section 21C of The Securities Exchange Act of 1934 ("Order") was issued on January 11, 1996, and served on Respondent American Aircraft Corporation ("AAC" or "Respondent") that same day. More than twenty days have elapsed since the Order was served on AAC and no answer has been received from it. As provided by Rules 155 and 220 of the Commission's Rules of Practice, 17 C.F.R.  201.155 and 201.220, AAC is hereby deemed to be in default, because it has not answered the Order. Furthermore, AAC's counsel stated to counsel for the Division that AAC did not object to entry of default. Accordingly, I find the following allegations, as set forth in the Order, to be true: A. THE RESPONDENT AAC was primarily engaged in developing vertical flight aircraft but had not succeeded in selling any of its aircraft. AAC's common stock was quoted on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") until April 1993, when it was delisted for failure to meet asset, equity and bid price requirements. On December 20, 1994, AAC voluntarily filed for Bankruptcy under Chapter 11 (Bankr. N.D. Cal. Case No. 94-12938). On August 14, 1995 AAC converted its Chapter 11 Bankruptcy to Chapter 7. Charles Sims is AAC's court appointed trustee for the Chapter 7 proceeding and had no ==========================================START OF PAGE 2====== affiliation with AAC prior to September 1995. B. BACKGROUND On March 4, 1988, AAC, a public company, and Phalanx Organization, Inc. ("Phalanx"), a private company, completed a reverse acquisition in which AAC acquired Phalanx's operations and management. As a result of the acquisition, Phalanx's president and controlling shareholder became president and CEO of AAC (the "President"). After the acquisition, AAC was reportedly developing several aircraft capable of vertical flight. In August 1990, AAC suspended all development work except for the Penetrator helicopter, which was a material modification of an existing UH-1 Huey helicopter. In 1991, AAC completed construction of a single pre-production prototype of the Penetrator helicopter, which has not yet completed testing. AAC and its officers and employees had little or no expertise in accounting or Generally Accepted Accounting Principles ("GAAP"). AAC's bookkeeper told the President in December 1988 that the President should hire a capable accountant who could properly prepare AAC's financial statements. The President did not hire such an accountant. As described below, during fiscal years ended November 30, 1988 through November 30, 1991, AAC valued certain aircraft designs (the "Designs"), which in fact had no reportable value, as assets under GAAP, and capitalized as assets certain research and development ("R&D") costs that should have been expensed. As a result, AAC materially overstated its assets in amounts ranging from $5,509,069 to $7,097,332 and materially understated its net losses in amounts ranging from $366,062 to $1,153,829 for fiscal years 1988 through 1991 in interim and annual financial statements filed with the Commission in Forms 10-Q and 10-K. C. AAC MATERIALLY OVERSTATED THE VALUES OF ITS ASSETS 1. The Designs The President, then affiliated with Phalanx, developed the Designs, with virtually no monetary investment, between July 1987 and February 1988. AAC, as part of the AAC-Phalanx reverse acquisition, acquired the Designs from the President for 2.5 million AAC restricted shares on February 17, 1988. Under GAAP, AAC was required to report the Designs at the President's basis, which was zero, because AAC acquired the Designs from the President in connection with a reverse acquisition. See Accounting Principle Board Opinion No. 16, 70; see also Staff Accounting Bulletin Topic 2.A. Instead, from its second quarter fiscal 1988 Form 10-Q through its fiscal 1991 Form 10-K, AAC reported the Designs as assets valued at $4,687,500 before amortization. As a result, ==========================================START OF PAGE 3====== the Designs represented at least 50% of AAC's total assets in each filing. In fact, GAAP required that AAC report the Designs as having a zero value. As a result of attributing a value to the Designs, AAC materially overstated its total assets in its Forms 10-K and 10-Q from the second quarter of its fiscal 1988 through the end of its fiscal 1991. In improperly valuing and recording the Designs as an AAC asset at $4,687,500, AAC used 50% of the then NASDAQ quoted $3.75 per share price of its own common stock to value the 2.5 million shares exchanged. 2. The R&D Costs AAC, during fiscal years 1988 through 1991, improperly capitalized certain R&D costs as tooling and inventory assets. GAAP requires that R&D costs be expensed as incurred. FAS 2, 12. AAC falsely represented in its Forms 10-K and 10-Q that AAC expensed R&D costs when incurred. As a result of improperly capitalizing R&D costs, from fiscal year 1988 through 1991, AAC materially overstated its assets by amounts ranging from approximately $821,569 to $3,288,738 and materially understated its net losses by amounts ranging from approximately $366,062 to $1,153,829. a. The Tooling For fiscal years 1988 through 1991, AAC improperly reported as assets tooling costs related to its preproduction prototypes. AAC's auditor told the President, prior to AAC filing its Forms 10-K with the Commission, that the tooling costs, as well as the prototype costs discussed below, were R&D and should have been expensed. The President nevertheless signed management representation letters to AAC's auditor stating that the tooling was properly capitalized because the projects related to the tooling were beyond the R&D stage. Contrary to the management letter representations, AAC disclosed in its 1990 and 1991 Forms 10-K that it had not in fact completed development of any of its proposed products. Nevertheless, in its Forms 10-K for fiscal years 1988 through 1991, AAC materially overstated its assets by reporting tooling costs as assets at amounts ranging from approximately $776,350 to $1,228,711, net of amortization. AAC's reporting the tooling as assets rather than expenses also resulted in it materially understating its net losses in Forms 10-Q and 10-K for fiscal years 1988 through 1991 in amounts ranging from approximately $315,000 to $862,649. b. The Prototype During its fiscal years 1990 through 1991, AAC capitalized certain costs related to the manufacture of prototypes. AAC disclosed in its fiscal 1991 Form 10-K that since January 1990, ==========================================START OF PAGE 4====== it had been developing the Penetrator helicopter, consisting of major technological modifications to the obsolete UH-1 Huey helicopter. AAC's fiscal 1991 Form 10-K further disclosed that AAC had produced a single Penetrator, a "proof of concept" version, that would be disassembled and analyzed at the completion of test flights. AAC improperly reported preproduction prototype development costs as inventory assets in its Forms 10-K and 10-Q for fiscal years 1990 and 1991 in the amounts of $998,618 and $2,512,388, respectively. As a result of capitalizing these costs, AAC materially understated net losses for fiscal years 1990 and 1991 by $948,618 and $1,563,770 respectively. D. AAC VIOLATED THE FEDERAL SECURITIES LAWS 1. AAC violated Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder in that it, by engaging in the conduct described in Section C. above, in connection with the purchase or sale of securities, directly or indirectly, by the use of means or instrumentalities of interstate commerce, or of the mails, or of the facilities of a national securities exchange, with scienter: a. employed devices, schemes or artifices to defraud; b. made untrue statements of material fact or omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; or c. engaged in acts, practices, or courses of business which operated or would operate as a fraud or deceit upon other persons. 2. AAC violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder in that it, by engaging in the conduct described in Section C above, filed with the Commission annual reports on Commission Form 10-K and quarterly reports on Commission Form 10-Q for the periods ending February 29, 1988, through November 30, 1991, which reports contained untrue statements of material fact and omitted to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. 3. AAC violated Section 13(b)(2) of the Exchange Act in that it, by engaging in the conduct described in Section C. above: a. failed to make and keep books, records, and ==========================================START OF PAGE 5====== accounts, which, in reasonable detail, accurately and fairly reflected the transactions and dispositions of its assets; and b. failed to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary (i) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (ii) to maintain accountability for assets. Based on the foregoing, I find that it is in the public interest to sanction AAC pursuant to Section 21C of the Exchange Act. IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that: AAC cease and desist from committing or causing any violations and any future violations of Sections 10(b), 13(a) and 13(b)(2) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. ______________________________ Lillian A. McEwen Administrative Law Judge SERVICE LIST Securities and Exchange Commission Division of Enforcement Branch of Regional Office Assistance Mail Stop 4-8B Attn: Laurie E. Stewart 450 Fifth Street, N.W. Washington, D.C. 20549 American Aircraft Corp. c/o Mr. Charles Sims Court Appointed Chapter 7 Trustee 37 Old Courthouse Square Santa Rosa, CA 95404 Steven Olson, Esq. Gary, Shea, O'Donnel and Grattan P.O. Boc 429 Santa Rosa, CA 95404 Karen Matteson, Esq. Roger D. Boudreau Securities and Exchange Commission 5670 Wilshire Blvd., 11th floor Los Angeles, CA 92103