UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 37147 / April 29, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 776 / April 29, 1996 Administrative Proceeding File No. 3-8993 --------------------------- ) In the Matter of ) ORDER INSTITUTING PROCEEDINGS ) PURSUANT TO SECTION 21C OF THE THOMAS J. MACCORMACK, ) SECURITIES EXCHANGE ACT OF 1934, ) AND FINDINGS AND ORDER OF THE Respondent ) COMMISSION ----------------------------) I. The Commission deems it appropriate and in the public inter- est that proceedings be, and they hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Thomas J. MacCormack violated Section 10(b) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder in connection with the filing by Kendall Square Research Corporation ("Kendall Square" or "the Company") of an annual report on Form 10-K for the year ended December 26, 1992, quarterly reports on Form 10-Q for the first two quarters of 1993, and a registration statement on Form S-1, which was declared effective in March 1993, and whether MacCormack violated Section 10(b) of the Exchange Act and Rule 10b-5 in connection with his sales of Kendall Square common stock in August 1993. II. In anticipation of the institution of these administrative proceedings, MacCormack has submitted an Offer of Settlement which the Commission has determined to accept. Under the terms of the Offer of Settlement, MacCormack, solely for the purposes of these proceedings and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice, and without admitting or denying the matters set forth herein, except as to jurisdiction, which MacCormack admits, consents to the issuance of this Order Instituting Proceedings Pursuant to Section 21C of the Exchange Act, and Findings and Order of the Commission. ==========================================START OF PAGE 2====== III. The Commission makes the following findings:-[1]- A. RESPONDENT AND RELEVANT ENTITY Thomas J. MacCormack, 41, was employed in the Company's pur- chasing department from 1988 until August 1992, when he was ap- pointed director of contract administration. MacCormack ceased employment with the Company in early 1994. On August 17, 1993, MacCormack sold 1,636 shares of the Company's common stock for approximately $34,000. Kendall Square Research Corporation, which is not a respondent in this proceeding,-[2]- is a Delaware corpora- tion with its principal executive offices in Waltham, Massachus- etts. Kendall Square designed, manufactured and marketed a fam- ily of high performance computer systems. The Company's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act, and traded on the NASDAQ national market system until April 1994, when it was delisted by the NASD. The Company is presently in a proceeding under the United States Bankruptcy Code. B. FACTUAL BACKGROUND 1. Kendall Square's False and Misleading Financial Statements This proceeding concerns violations of the anti-fraud and books and records provisions of the federal securities laws in connection with certain public filings of Kendall Square Research Corporation. These violations resulted from, among other things, the Company's recognition, in 1992 and during the first two ---------FOOTNOTES---------- -[1]- The findings herein are solely for the purposes of this proceeding and are not binding on any other person or entity named as a respondent in this or any other proceeding. -[2]- On April 29, 1996, the Commission filed a civil injunctive action against Kendall Square and its former officers Henry Burkhardt III, Karl G. Wassmann III and Peter Appleton Jones in the United States District Court for the District of Massachusetts. Civ. No. [ ]. The Commission's Complaint alleges, among other things, that all defendants violated the reporting and anti-fraud provisions of the federal securities laws in connection with Kendall Square's periodic and other filings with the Commission. ==========================================START OF PAGE 3====== quarters of 1993,-[3]- of revenue from sales subject to a variety of contingencies that made such recognition improper under Generally Accepted Accounting Principles ("GAAP"). Many of Kendall Square's customers were universities and research institutions which were dependant on other parties for financial support. Certain of these customers sought and obtained from Kendall Square "side letter" agreements providing that they would not be obligated to pay for their computer systems if they did not receive anticipated funding. Kendall Square senior management failed to inform their independent audi- tors, as well as Kendall Square's Finance Department, that transactions upon which the Company had recognized revenue were subject to such side agreements. With respect to other trans- actions, Company personnel did not conceal the existence of funding contingencies in the sales contracts, but misrepresented to their auditors the status of the customers' funding.-[4]- As a result of its improper revenue recognition practices, Kendall Square's financial statements, as incorporated in its annual report on Form 10-K for 1992, its quarterly reports on Form 10-Q for the first two quarters of 1993 and a registration statement on Form S-1 for a March 1993 secondary offering, were materially false and misleading. After management changes and other factors brought its improper revenue recognition practices to light, the Company determined to reverse approximately 50% of its previously reported revenue for 1992 and the first two quarters of 1993. From its October 1993 price of approximately $24 per share, Kendall Square common stock lost essentially all of its value. 2. MacCormack's Conduct As director of contract administration, MacCormack signed agreements with certain Kendall Square customers which rendered recognition of revenue on purported sales to those customers inconsistent with GAAP. With respect to a purported sale of a Kendall Square computer to Expersoft Corporation in the fourth quarter of 1992, MacCormack was the author of a December 23, 1992 letter to Expersoft stating that $650,000 of the total $1.15 million purchase price was contingent on Expersoft's receipt of government funding. Neither the invoice nor the sales contract ---------FOOTNOTES---------- -[3]- Kendall Square's 1992 fiscal year ended December 26, 1992. Its first and second quarters for fiscal 1993 ended March 27, 1993, and June 26, 1993, respectively. -[4]- As described below, MacCormack was involved with a limited number of the transactions upon which Kendall Square improperly recognized revenue. ==========================================START OF PAGE 4====== contained any such funding provision. As another example, Kendall Square originally recognized revenue of $397,000 in the first quarter and $979,000 in the second quarter of 1993 from the purported sale of a computer system to the Beckman Institute, an entity affiliated with the California Institute of Technology ("Caltech"). The purchase orders issued by Caltech for each of these transactions state that "Caltech will not assume any financial responsibility if [the director of the Beckman Insti- tute] is unable to raise funds for the purposes stated herein." MacCormack signed the purchase orders to acknowledge receipt by Kendall Square. MacCormack, as director of contract administration, was responsible for providing the Company's Finance Department with a complete set of sales documents to support the Company's revenue recognition decisions. However, as MacCormack knew or was reckless in not knowing, certain material documents were never forwarded to the Company's Finance Department, including those described above. Hence, these documents were not considered by the Company's controller as part of the Company's initial decision to recognize revenue on these transactions and were not provided to the Company's independent auditors to inform their consultation on revenue issues. This resulted in the Company reporting revenue in the financial statements contained in its public filings that was not in conformity with GAAP.-[5]- In addition to the foregoing, MacCormack sold 1,636 shares of the Company's common stock, representing 100% of his holdings, for approximately $34,000 on August 17, 1993. At the time of his sale of the Company's common stock, MacCormack knew or was reckless in not knowing that the Company's financial statements were false and misleading in that they included revenue from purported sales of the Company's product that was not in conformity with GAAP. At the close of the market on March 28, 1994, the first full trading day after the Company released its restated financial results, the share price of Kendall Square stock was $4.375. Consequently, MacCormack avoided losses of -[5]- In the case of both the Expersoft and Caltech transactions, for example, the Company originally recognized revenue that, because of the funding contingencies described above, was not in conformity with GAAP. The Company never received the contingent payments for these computer systems, and subsequently reversed all purported revenue from this source when it restated the financial statements incorporated in its 1992 Form 10-K, and Forms 10-Q for the first two quarters of 1993. ==========================================START OF PAGE 5====== approximately $26,800 by selling his Kendall Square stock while in possession of material nonpublic information. C. LEGAL ANALYSIS Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit material misstatements or omissions, made with scienter, in connection with the purchase or sale of securities. See, e.g., SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). Financial statements incor- porated in periodic reports filed with the Commission which are not prepared in accordance with GAAP "are presumed to be mislead- ing." Regulation S-X, Rule 4-01(a)(1). In the financial statements incorporated in its Form 10-K for 1992 and in its Forms 10-Q for the first and second quarters of 1993, Kendall Square reported substantial revenue from sales transactions which did not conform to GAAP requirements.-[6]- As described above, MacCormack contributed to Kendall Square's revenue recognition practices that resulted in Kendall Square's fraudulent filings with the Commission. MacCormack knew or was reckless in not knowing that he was doing so. Hence, he acted with scienter for purposes of Section 10(b) and Rule 10b-5. Violations of Section 10(b) and Rule 10b-5 also occur when an officer or director or other corporate fiduciary buys or sells securities while in possession of material nonpublic information. Dirks v. SEC, 463 U.S. 646, 653-54 (1983). At the time of his sale of 1,636 shares of Kendall Square common stock, MacCormack, as he knew or was reckless in not knowing, was in possession of material nonpublic information relating to the Company's true financial condition, results of operation and prospects for the future. Rule 13b2-1 provides that: "No person shall, directly or indirectly, falsely or cause to be falsified, any book, record or account subject to Section 13(b)(2)(A) of the Securities Exchange Act." MacCormack, through his acts and omissions with respect to the failure of Kendall Square's Contract Administration Department to provide the Company's Finance Department with material documents concerning purported sales of Kendall Square's products, caused Kendall Square's books and records to be falsified in violation of Rule 13b2-1. V. ---------FOOTNOTES---------- -[6]- The financial statements incorporated in Kendall Square's 1992 Form 10-K were also incorporated in the Form S-1 registration statement for its March 1993 public offering. ==========================================START OF PAGE 6====== Based upon the foregoing, the Commission finds that: A. Thomas J. MacCormack violated Section 10(b) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder. VI. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Respondent's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that: A. Thomas J. MacCormack cease and desist from committing or causing violations and any future violations of Section 10(b) of the Exchange Act and Rules 10b-5 and 13b2-1; and B. MacCormack shall, pursuant to Section 21C(e) of the Exchange Act, pay to the United States Treasury disgorgement in the amount of $26,800, plus prejudgment interest in the amount of $4,872.75, pursuant to Rule 600 of the Commission's Rules of Practice, 17 C.F.R. 201.600, with payment of $7,500 due thirty days after the date of this Order and the remaining $24,172.75 due one year after the date of this Order. Interest on amounts not timely paid shall continue to accrue until they are paid. Such payment shall be (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the Securities and Exchange Commission; (3) hand- delivered to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; and (4) submitted under cover letter which identifies MacCormack as a Respondent in these proceedings, the file number of these proceedings and the Commission case number (HO-2810), a copy of which cover letter and form of payment shall be sent to Gary N. Sundick, Associate Director, Division of Enforce- ment, Securities and Exchange Commission, Mail stop 4- 1, 450 Fifth Street, N.W., Washington, D.C. 20549. By the Commission. Jonathan G. Katz Secretary