UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 37905 / October 31, 1996 Accounting and Auditing Enforcement Release No. 852 / October 31, 1996 Administrative Proceeding File No. 3-9179 --------------------- : In the Matter of : ORDER INSTITUTING PUBLIC : PROCEEDING PURSUANT TO Troy Lee Wood : SECTION 21C OF THE SECURITIES : EXCHANGE ACT OF 1934, MAKING Respondent : FINDINGS, AND CEASE- : AND-DESIST ORDER --------------------- I. The Securities and Exchange Commission deems it appropriate that a public administrative proceeding, pursuant to Section 21C of the Securities Exchange Act of 1934, be, and hereby is instituted against Troy Lee Wood. In anticipation of this proceeding, Respondent has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the Commission's findings or conclusions contained herein, Respondent consents to the issuance of this Order Instituting Public Proceeding Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Cease-and-Desist Order. ==========================================START OF PAGE 2====== II. The Commission makes the following findings: A. Respondent Troy Lee Wood, age 43, resides in Arlington, Texas. From 1986 until August 1994, Wood was President of National Health Services, Inc. ("National Health"), a telemarketing company that produces leads for the sale of insurance and other products to small businesses and consumers. B. Issuer Automated Telephone Management Systems, Inc. ("ATM"), a company located in Richardson, Texas, conducted its initial public offering on May 3, 1993. From May 1993 through August 1994, ATM's preferred stock was registered with the Commission pursuant to Section 12(b) of the Exchange Act. During the same period, ATM's preferred stock was quoted over-the-counter on the National Association of Securities Dealers, Inc. Automated Quotation System ("NASDAQ"), and listed for trading on the Boston Stock Exchange. In August 1994, ATM's stock was delisted by NASDAQ, and in September 1994, it was delisted from the Boston Stock Exchange. Since the second quarter of 1994, ATM has failed to file any required periodic or annual report, and has ceased operations. C. Background This matter arises out of a scheme to inflate revenue and income reported by ATM. In its financial statements contained in its annual report on Form 10-K filed with the Commission for fiscal year ended September 30, 1993, ATM reported revenue of $4,894,710. However, as a result of a fraudulent accounting scheme by senior management of ATM, which employed improper revenue recognition practices, ATM's reported revenue was materially overstated by approximately $1.5 million--about thirty percent of ATM's reported revenue for fiscal 1993. Most of the revenue that was recognized improperly was attributable to a $1.3 million sale to National Health. Akhilesh Chandoke, then President and CEO of ATM, and David H. Jacobs, then Vice-President of Sales and Marketing for ATM, asked Wood to execute a fictitious contract for the purported sale of $1.3 million worth of ATM equipment to National Health. Chandoke and Jacobs told Wood that National Health would not be required to take delivery of the equipment or to pay for it. Wood executed three documents that were used by Chandoke and Jacobs to support the improper recognition of the $1.3 million in revenue: (1) a purported sales contract; (2) a "Confirmation of Installation" form; and (3) an audit confirmation letter. The audit ==========================================START OF PAGE 3====== confirmation was provided to ATM's independent auditors. In return, in part, for signing the documents, Wood received gifts and payments totaling approximately $17,000 from ATM through the company's officers. D. Wood's Participation in ATM's Improper Revenue Recognition From 1988 through 1991, National Health purchased several automated dialing systems ("ADS") and related equipment from ATM, and was one of ATM's largest customers. As National Health's President, Wood dealt with Jacobs frequently and often socialized with Jacobs. In September 1993, Chandoke and Jacobs persuaded Wood to execute on behalf of National Health a contract for the purchase of $1,346,875 of ATM software and equipment. Jacobs assured Wood that the contract would not be binding upon National Health and it was therefore fictitious. Later, at the request of Jacobs, Wood also executed a "Confirmation of Installation" form, which stated falsely that ATM had, on September 27, 1993, completed installation of the equipment described in the fictitious contract. ATM then recorded the $1.3 million in revenue from the sale on its financial statements. In order to persuade ATM's independent auditors, Bailey, Vaught, Robertson & Company ("Bailey Vaught"), that the $1.3 million sale was a bona fide transaction, Chandoke, Mzyk and Jacobs provided the auditors with the fictitious sales contract and the fictitious Confirmation of Installation form signed by Wood. Furthermore, in connection with the 1993 fiscal year end audit, Wood received an audit confirmation request from ATM asking Wood to confirm directly to Bailey Vaught that, as of September 30, 1993, National Health was indebted to ATM in the amount of approximately $1.5 million, an amount which included the $1.3 million fictitious sale. The letter stated that Bailey Vaught was "making an annual audit of" ATM's financial statements. Chandoke and Jacobs requested that Wood sign and submit the false accounts receivable confirmation to Bailey Vaught. Despite Wood's knowledge that the $1.3 million contract was fictitious and not binding upon National Health, Wood signed the account receivable confirmation on November 8, 1993, and caused it to be returned to ATM's independent auditor. The November 8, 1993 confirmation letter was materially false in that it verified that National Health was indebted to ATM as of September 30, 1993, in the amount of approximately $1.5 million.-[1]- Bailey Vaught issued an unqualified opinion on ATM's financial statements for fiscal 1993. The materially misstated financial ---------FOOTNOTES---------- -[1]- Of the $1.5 million reflected in the confirmation, National Health actually only owed ATM $273,000, for equipment that National Health purchased from ATM in June 1993. ==========================================START OF PAGE 4====== statements were included in ATM's annual report on Form 10-K, filed with the Commission on January 13, 1994. Wood's execution of the fictitious contract and the audit confirmation were in return, in part, for receipt of payments and gifts from ATM, totalling approximately $17,000. Such payments and other gifts to Wood were arranged and approved by Chandoke and Jacobs, who caused ATM's accounting department to falsely record the payments as commissions for sales referrals. Wood submitted the accounts receivable confirmation to ATM's independent auditor knowing that it was false and knowing that Bailey Vaught would rely on this letter in connection with its year-end audit of ATM's financial statements. Moreover, Wood knew that ATM, as a public company, would publicly disseminate its financial statements as part of its annual report. On November 1, 1995, the Commission filed an injunctive action against ATM, alleging violations of Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder, and against Chandoke, Mzyk and Jacobs, alleging violations of Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5, 13b2-1 and 13b2-2 thereunder. SEC v. Automated Telephone Management Systems, Inc., et al., U.S. Dist. Ct., N.D. Tex., Dallas Div., C.A. No. 395-CV2613-X (Nov. 1, 1995) (Litigation Release No. 14710 / AAER No. 735; November 2, 1995). On January 30, 1996, the district court entered a default judgment against ATM, enjoining it from violations of Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) of the Exchange Act, and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. Chandoke and Mzyk agreed, without admitting or denying the allegations contained in the Commission's complaint, to settle the action pending against them. On March 26, 1996 and March 28, 1996 respectively, the Court entered the agreed judgments against Chandoke and Mzyk, permanently enjoining them from committing future violations Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and imposing a ten-year officer and director bar against each of them. On April 1, 1996, the court entered a default judgment against Jacobs, enjoining him from future violations of Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5, 13b2-1, 13b2-2 thereunder, and permanently prohibiting him from serving as an officer or director of a reporting company.-[2]- ---------FOOTNOTES---------- -[2]- The United States Attorney's Office for the Northern District of Texas ("USAO") pursued criminal charges against Chandoke, Mzyk, Jacobs, and Wood. United States v. Akhilesh Chandoke, et al., Crim No. 3-95-CR-333-X (Nov. 1, 1996). Chandoke and Jacobs each pleaded guilty to a single count of bank fraud, pursuant to 18 U.S.C.  1014. After a jury trial, Mzyk was acquitted of bank fraud charges. (continued...) ==========================================START OF PAGE 5====== E. Legal Analysis 1. Wood Violated Section 10(b) of the Exchange Act and Rule 10b(5) thereunder Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit the making of materially false and misleading statements "in connection with the purchase or sale of any security." The materiality element is satisfied by showing that there is a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of a reasonable investor. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). The defendants must also act with scienter, Aaron v. SEC, 446 U.S. 680, 694 (1980), which is "a mental state embracing intent to deceive, manipulate or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12 (1976). Wood violated Section 10(b) and Rule 10b-5 in that he signed a fraudulent contract and false audit confirmation letter in order for ATM to report falsely inflated earnings in its financial statements. Wood knew that the documents would be used by Bailey Vaught in auditing ATM's financial statements for its fiscal year ended September 30, 1993. Wood also knew that the financial statements would be publicly disseminated to ATM's investors. As the Commission has recognized, "[t]he confirmation procedure is an integral and vital part of the auditing process. Subversion of the process corrupts the integrity of the audit and can injure investors by facilitating the injection of false financial information into the marketplace." In the Matter of Richard D. Lemmerman,, SEC Exchange Act Release No. (Sept. 26, 1991). See also In the Matter of Calvin Shenkir, Jr., SEC Exchange Act Release No. 3-8876 (Oct. 31, 1995); In the Matter of Terry Kuntz & Richard J. Scheer, SEC Exchange Act Release No. 36281 (Sept. 26, 1995). 2. Wood Caused Violations of Sections 13(a) and 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 Thereunder Section 21C of the Exchange Act applies to any person who "is, was or would be a cause of [a] violation due to an act or omission the person knew or should have known would contribute to ---------FOOTNOTES---------- -[2]-(...continued) Wood was charged with a single count of felony misprision, in violation of 18 U.S.C. 4, for his role in the ATM-National Health transaction. United States v. Troy Lee Wood, Crim. No. 3- 96CR-221-H (June 19, 1996). Pursuant to an agreement with the USAO, Wood has agreed to plead guilty and will be sentenced to three years probation and ordered to pay a fine of $17,000. ==========================================START OF PAGE 6====== such violation." The aforementioned conduct of Wood caused ATM to violate Section 13(a) of the Exchange Act, as well as caused Chandoke and Jacobs to violate Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 thereunder. Section 13(a) of the Exchange Act requires issuers of registered securities to file annual reports with the Commission reflecting, among other things, a registrant's annual revenues, income and net earnings. The reporting requirements of Section 13(a) necessarily require that the information provided be accurate. See In the Matter of Michael V. Barnes, SEC Exchange Act Release No. 33754, AAER 538 (March 11, 1994). ATM violated Section 13(a) of the Exchange Act by filing the materially false and misleading 1993 Form 10-K. ATM violated Section 13(a) by improperly recognizing and reporting revenue from the fictitious contract in its 1993 Form 10-K, contrary to its stated revenue recognition policy of recognizing revenue at the time of installation, as well as Generally Accepted Accounting Principles ("GAAP"). As discussed above, ATM's improper recognition of revenue from the $1.3 million fictitious contract contributed to a material overstatement of its net income for fiscal 1993. Wood was a cause of this material overstatement by knowingly signing the false sales contract and installation confirmation and furnishing the accounts receivable confirmation letter to ATM's independent auditors which falsely verified that as of the end of fiscal 1993, National Health owed $1.5 million to ATM. Section 13(b)(5) of the Exchange Act prohibits any person from knowingly circumventing or knowingly failing to implement a system of internal accounting controls, or knowingly falsifying any book, record, or account that an issuer is required to maintain. Rule 13b2-1 under the Exchange Act prohibits any person from, directly or indirectly, falsifying or causing the falsification of, any book, record or account required by Section 13(b)(2)(A) of the Exchange Act. Rule 13b2-2 of the Exchange Act prohibits officers and directors of an issuer from, directly or indirectly, making or causing to be made materially false or misleading statements, or omitting to state, or causing another person to omit to state, any material fact in order to make statements made not misleading to an accountant in connection with any audit or examination of the financial statements required to be filed with the Commission, or the preparation or filing of any document or report required to be filed with the Commission. Chandoke and Jacobs violated Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder by having Wood sign the purported contract and false audit confirmation. Chandoke and Jacobs violated Rule 13b2-2 of the Exchange Act by knowingly providing the purported contract and false audit confirmation to Bailey Vaught in connection with their audit. Accordingly, Wood was a cause of ATM's violations of Section 13(a) of the Exchange ==========================================START OF PAGE 7====== Act, and Chandoke's and Jacobs' violations of Section 13(b)(5) of the Exchange Act, and Rules 13b2-1 and 13b2-2 thereunder. III. FINDINGS Based on this Order and the Offer of Settlement submitted by Wood, the Commission finds that Wood violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and caused violations of Sections 13(a) and 13(b)(5) of the Exchange Act, and Rules 13b2-1 and 13b2-2 thereunder. ==========================================START OF PAGE 8====== IV. ORDER Accordingly, IT IS HEREBY ORDERED THAT: A. Pursuant to Section 21C of the Exchange Act that Troy Lee Wood cease and desist from committing or causing any violations and any future violations of Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b- 5, 13b2-1 and 13b2-2 thereunder; and B. Pursuant to Section 21C of the Exchange Act that Troy Lee Wood cease and desist from causing any violation and causing any future violation, of Section 13(a) of the Exchange Act. By the Commission. Jonathan G. Katz Secretary