UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 38876 / July 28, 1997 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 941 / July 28, 1997 ADMINISTRATIVE PROCEEDING File No. 3-9247 ORDER SETTLING CEASE-AND- DESIST PROCEEDINGS, MAKING In the Matter of: FINDINGS AND IMPOSING A CEASE-AND-DESIST ORDER WILLIAM D. KYLE, Respondent. I. The Securities and Exchange Commission ("Commission") has previously instituted cease-and-desist proceedings pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against William D. Kyle ("Kyle" or "Respondent").<(1)> Kyle subsequently has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. II. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that Respondent admits the jurisdiction of the Commission over him and over the subject matter of this proceeding, Respondent consents to the issuance of this Order Settling Cease-and-Desist Proceedings, Making Findings and Imposing a Cease-and-Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below. <(1)> The Commission instituted the cease-and-desist proceeding on February 18, 1997. See Securities Exchange Act Release No. 38297. III. On the basis of this Order and Respondent's Offer, the Commission finds<(2)> the following: A. RESPONDENT Respondent Kyle was, from May 1993 to January 1996, National Sales Manager of Midisoft Corporation ("Midisoft" or "the Company"). B. ENTITY INVOLVED Midisoft, founded in 1986, is a Washington State corporation with its principal place of business in Issaquah, Washington. Midisoft develops and markets interactive, audio-based software applications for the Microsoft Windows and multimedia applications market, including software that allows users to produce and manipulate music on a personal computer. The Company's common stock has been registered with the Commission pursuant to Section 12(g) of the Exchange Act since July 1993 and is quoted on The NASDAQ Stock Market. For the most recent fiscal year, ended December 31, 1996, the Company posted revenues of $3,113,000, a net loss of $5,716,000 and a net loss per share of $1.22. As of March 10, 1997, with 5,624,951 shares outstanding and a closing price per share of $1.88, Midisoft had an aggregate market value of $10,574,907. C. FACTS 1. Midisoft's Internal Accounting Policies and Practices Regarding Purchase Orders. At all relevant times, Midisoft's internal accounting policy, as set forth in the Company's 1994 Form 10-K, stated that the Company recognized revenues on sales to distributors, resellers and other end-users only when products were shipped to those customers. During the fiscal year ended December 31, 1994, the process of shipping goods to a distributor typically began with the receipt by Midisoft of a written purchase order from the customer. The sales administrator for distributor sales (the "Sales Administrator"), who reported directly to Kyle, would then enter the purchase order into Midisoft's computer accounting system, known as Macola. The information the Sales Administrator input into the Macola system was used by Midisoft's Shipping Department to determine what orders to fill and ship. The Shipping Department typically filled and shipped orders input into the Macola system as soon as possible in the normal course of business. Then, once the Shipping Department obtained documentation <(2)> The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding. ======END OF PAGE 2====== showing that the goods had been shipped, Midisoft's Accounting Department could book the revenues associated with the shipment, in accordance with the Company's stated policy. On occasion, some Midisoft customers would place orders which they did not want to have delivered in the normal course of business, but rather desired to have delivered at some later date, or upon later instructions. In these instances, it was the practice of the Sales Administrator to input the purchase order into the Macola system with a special notation that the order was to be filled at a specific later date, or upon the receipt of further instructions. 2. Conduct Leading to Midisoft's Materially Misleading Form 10-K for Fiscal 1994. In December 1994, at the direction of certain Midisoft officers, Kyle and another Midisoft salesperson who reported directly to Kyle obtained written purchase orders from two of Midisoft's distributor customers (the "Contingent Purchase Orders"). Kyle knew that the distributors had agreed to provide the Contingent Purchase Orders to Midisoft based on the understanding that Midisoft would not ship goods relating to these orders in the normal course of business. Rather, as Kyle was aware, these distributors expected Midisoft to delay shipping some or all of the goods relating to the Contingent Purchase Orders until such time as the distributors provided Midisoft with further instructions. Kyle directed the Sales Administrator to enter the Contingent Purchase Orders into the Macola system. At the time, Kyle was aware of the contingent nature of these orders, and was aware that the orders themselves did not contain any notation as to a delay in shipping. Nevertheless, Kyle did not instruct the Sales Administrator to include in the Macola system any notation regarding a delay in shipping. Because Midisoft did not expect to ship goods relating to the Contingent Purchase Orders in the normal course of business, Midisoft could not have expected to recognize revenues on these orders during fiscal 1994. To address this problem, certain Midisoft officers directed Kyle to go back to his customers and obtain written confirmations that the customers would take title to the goods relating to the Contingent Purchase Orders during fiscal 1994 at a Midisoft warehouse. In this way, Midisoft hoped to recognize revenues on the Contingent Purchase Orders during ======END OF PAGE 3====== fiscal 1994, without actually shipping the goods to its customers during that year. Kyle attempted but was unable to obtain any such written confirmations and he informed at least one Midisoft officer of this fact in December 1994. Despite this, at no time did Kyle direct his Sales Administrator to cancel the Contingent Purchase Orders from the Macola system, nor did he instruct the Sales Administrator to include in the Macola system any notation regarding a delay in shipping these orders. In a meeting in late December 1994 certain Midisoft officers and employees discussed the fact that, despite Kyle's inability to obtain agreements from his customers regarding taking title to the goods at a Midisoft warehouse, Midisoft would recognize revenues relating to the Contingent Purchase Orders in fiscal 1994.<(3)> Midisoft carried out this plan, in part, by storing the goods at a freight forwarding company and obtaining phony documents from the freight forwarder to indicate that the goods had been shipped on or prior to December 31, 1994. From January through March of 1995, Midisoft had to manage the stock of goods stored at the freight forwarder relating to the Contingent Purchase Orders. To do this, the Sales Administrator prepared a computer worksheet that showed each of the Contingent Purchase Orders, the amount (if any) of goods relating to that order that Midisoft actually shipped on or prior to December 31, 1994, the amount of each subsequent shipment against that order, and the amount of goods still remaining at the freight forwarder. From time to time during the first three months of 1995, the Sales Administrator provided a copy of this worksheet to Kyle. During that time, Kyle periodically instructed the Sales Administrator to release certain goods held at the freight forwarder for delivery to Midisoft's customers. The worksheet prepared by the Sales Administrator was not integrated into Midisoft's established internal accounting system. As a result, Midisoft was able to manage the goods stored at the freight forwarder without alerting the Company's outside auditors, who were then auditing Midisoft's 1994 fiscal results. Moreover, Kyle was aware during this period that the purpose of storing the goods at the freight forwarder was to allow Midisoft to recognize revenues on those goods during fiscal 1994, prior to the time they were actually shipped to Midisoft customers. In late March 1995, just prior to the end of the first quarter of Midisoft's 1995 fiscal year, Midisoft arranged to receive back from the freight forwarder all the remaining goods relating to the Contingent Purchase Orders. On or about April 14, 1995, Midisoft filed its original Form 10-K with the Commission for the fiscal year ended December 31, 1994. When compared with the Company's Amended Form 10-K for fiscal 1994, which Midisoft filed on or about August 8, 1995, the original Form 10-K overstated the Company's <(3)> Kyle did not attend this late December 1994 meeting. ======END OF PAGE 4====== revenues for fiscal 1994 by a total of $811,000, all of which occurred in the fourth quarter. Of this total, approximately $292,000 was the result of the recognition of revenue on the Contingent Purchase Orders for the goods that Midisoft did not ship to customers during fiscal 1994. Without the overstated revenues, Midisoft would have reported revenues for fiscal 1994 and for the fourth quarter of the year of $4,989,000 and $685,297, respectively. D. LEGAL ANALYSIS 1. Kyle Caused Midisoft to Violate Provisions Governing Issuer Reporting, Books And Records and Internal Accounting Controls. Pursuant to Section 21C of the Exchange Act, a person is a cause of a violation of the provisions of the Exchange Act if the violation occurs because of an act or omission which the person knew or should have known would contribute to such violation. For the reasons set forth below, Kyle caused Midisoft to violate Section 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder. a. Issuer Reporting Provisions: Section 13(a) and Rules 12b-20 and 13a-1 Section 13(a) of the Exchange Act and Rule 13a-1 thereunder require that issuers whose securities are registered with the Commission pursuant to Section 12 of the Exchange Act file with the Commission accurate annual reports. Exchange Act Rule 12b-20 requires that such reports contain any additional information necessary to ensure that the required statements in the reports are not, under the circumstances, materially misleading. Thus, the filing of a periodic report that contains materially false and misleading statements or omissions constitutes a violation of the reporting provisions of the Exchange Act. Violations of the reporting provisions do not require a showing of scienter. SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1166-67 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Financial statements incorporated in Commission filings must comply with Regulation S-X, which in turn requires conformity with Generally Accepted Accounting Principles ("GAAP"). Statement of Financial Accounting Concepts No. 5 ("CON5"), entitled "Recognition and Measurement in Financial Statements of Business Enterprises," states that revenue should be recognized when it is both realized (or realizable) and earned. Paragraph 83 of CON5 states that revenue is realizable when a product is "exchanged for cash or claims to cash" and revenue is earned "when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." In addition, Midisoft's own revenue recognition policy, as set forth in its original 1994 Form 10-K, required that it recognize revenue only after it shipped products to its customers. By including in its original Form 10-K for 1994 $292,000 in revenues relating to the Contingent Purchase Orders, Midisoft overstated both its fiscal year revenues and its revenues for the fourth quarter by 5.8% and 42.6% respectively, as compared with the Company's amended Form 10-K for ======END OF PAGE 5====== 1994. This misstatement was material. See Basic v. Levinson, 485 U.S. 224, 231-32 (1988) (fact is material if there is substantial likelihood reasonable investor would consider it important in making investment decision); see also In re Gupta Corporation Securities Litigation, 900 F. Supp. 1217, 1231 (N.D. Cal. 1994) (materiality of overstatement of revenues greater than 5% "is beyond question"). As a result, Midisoft violated Section 13(a) and Rules 12b-20 and 13a-1. Moreover, Kyle knew or should have known that the following of his actions or omissions would contribute to Midisoft issuing the materially misleading Form 10-K for fiscal 1994: (1) failing to instruct the Sales Administrator to include in the Macola System a notation of the fact that Midisoft had agreed that it would not deliver goods relating to the Contingent Purchase Orders unless and until it received further instructions from its customers, even after the customers had refused to take delivery of the goods at a Midisoft warehouse; and (2) instructing the Sales Administrator during the first three months of 1995 to make shipments out of the stock of goods held at the freight forwarder, even though Kyle then knew that Midisoft intended to recognize these goods as revenues during fiscal 1994 and that the Company was specifically storing the goods at the freight forwarder to carry out its scheme. Accordingly, Kyle was a cause of Midisoft's violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13(a) thereunder. b. Books and Records and Internal Accounting Controls: Section 13(b)(2)(A) and 13(b)(2)(B) Section 13(b)(2)(A) requires that each issuer of securities registered pursuant to Section 12 of the Exchange Act make and keep books, records and accounts that accurately and fairly reflect the dispositions of its assets. Section 13(b)(2)(B) requires that each such issuer also devise and maintain a system of sufficient internal accounting controls. By failing to instruct the Sales Administrator to enter the Contingent Purchase Orders correctly in Midisoft's computer accounting system even after the distributors had refused to take delivery at a Midisoft warehouse, and by later directing the shipment of goods stored at the freight forwarder relating to the Contingent Purchase Orders, Kyle was a cause of Midisoft's failure to keep books, records and accounts that accurately reflected the disposition of the goods covered by those purchase orders, in violation of Section 13(b)(2)(A). In addition, Kyle's conduct was a cause of Midisoft's failure to maintain a system of sufficient internal accounting controls, in violation of Section 13(b)(2)(B). 2. Kyle Also Violated Certain Books and Records and Internal Accounting Controls Provisions. 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. Rule 13b2-1 thereunder similarly prohibits any person, whether indirectly or directly from falsifying or causing to be falsified any book, record or account. ======END OF PAGE 6====== Kyle violated Section 13(b)(5) and Rule 13b2-1 when he failed to instruct the Sales Administrator to enter the Contingent Purchase Orders correctly in Midisoft's computer accounting system even after the distributors had refused to take delivery at a Midisoft warehouse. In addition, Kyle further knowingly circumvented Midisoft's internal accounting controls when he instructed the Sales Administrator to ship goods stored at the freight forwarder relating to the Contingent Purchase Orders, even though he knew that such shipments were not properly reflected in Midisoft's books and records. 3. Kyle Was Also a Cause of Midisoft's Violation of Section 10(b) and Rule 10b-5 Thereunder. 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. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The Ninth Circuit has held expressly that a mental state of recklessness is sufficient to satisfy the scienter requirement. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc) (as amended), cert. denied, 449 U.S. 976 (1991). Where the fraud alleged involves public dissemination in an annual report or other such document on which an investor would presumable rely, the "in connection with" requirement is generally met by proof of the means of dissemination and the materiality of the misstatement. SEC v. Rana Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) (issuance of press release coupled with public trading in stock met requirement); Savoy Industries, 587 F.2d at 1171 (filing of Schedule 13D coupled with public trading in stock satisfies requirement). Midisoft's original 1994 Form 10-K was materially false and misleading because it contained the $292,000 in revenues relating to the Contingent Purchase Orders for goods that were not shipped during fiscal 1994. Kyle knew of or recklessly disregarded the fact that his actions as described above would contribute to the issuance of this materially false report. Accordingly, Kyle was a cause of Midisoft's violation of Section 10(b) and Rule 10b-5 thereunder. IV. Based on the foregoing, the Commission finds that Kyle: 1. committed violations of Section 13(b)(5) of the Exchange Act, and Rule 13b2-1 thereunder; and 2. was a cause of the 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 and 13a-1 thereunder. V. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Kyle cease and desist from: ======END OF PAGE 7====== 1. committing or causing any violation and any future violation of Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5 and 13b2-1 thereunder; and 2. causing any violation and any future violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20 and 13a-1 thereunder. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 8======