UNITED STATES OF AMERICA
|Quarter ended||Reported||Restated||Difference||% change|
|12/28/97||$ 14,687||$ 12,734||$ 1,953||- 13.3%|
During the period when Gaffney was making these false entries in the general ledger of Hofmann Laces, he was also sending monthly reporting packages for Hofmann Laces to Guilford's headquarters in Greensboro, North Carolina. Gaffney's monthly reporting packages included formal financial statements, supplemental schedules, and sales and inventory information. Certain of these reports indicated, among other things, that inventories at Hofmann Laces were rapidly increasing at the same time that its accounts payable were rapidly decreasing. This apparent divergence was a direct result of Gaffney's false journal entries, though Guilford's personnel apparently believed that the divergence between Hofmann Laces' increasing inventories and its decreasing accounts payable was due, at least in part, to intercompany inventory purchases by Hofmann Laces from Guilford, which were reflected not in accounts payable but rather in a separate line item for intercompany transfers.
In any case, the false entries went undetected because, among other things, Gaffney retained sole and exclusive control over the Hofmann Laces general ledger, because no one at Guilford reviewed Gaffney's entries or adjustments to Hofmann Laces' general ledger, and because Guilford had not yet integrated the Hofmann Laces general ledger accounting system into its own.
5. Guilford's Discovery of the False Entries
Gaffney resigned his position and left Hofmann Laces in late September 1998. On Monday, October 26, 1998, after the stock market closed, Guilford issued a press release announcing that it had uncovered "potential accounting irregularities" at Hofmann Laces. The press release further announced that, as a result of the irregularities, operating income for Hofmann Laces appeared to have been overstated by approximately $10 million to $11 million, having a net effect on the company's consolidated pretax earnings in the range of $4.3 million to $6.5 million. Over the remainder of that week, the market price of Guilford's common stock experienced a short-term decline of approximately 23%, from $16.25 to $12.50 per share. On November 24, 1998, in a press release announcing its operating results for the fiscal quarter and fiscal year ended September 27, 1998, Guilford also announced that it would restate its financial results for the first three quarters of its fiscal year ended September 28, 1998.
B. LEGAL DISCUSSION
Exchange Act Section 13(a) and Rule 13a-13 thereunder require issuers of registered securities to file quarterly reports with the Commission on Form 10-Q. Courts have uniformly held that it is implicit in this requirement that the information reported in such periodic reports be accurate. See, e.g., SEC v. Savoy Indus., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Exchange Act Section 13(b)(2)(A) requires issuers to "make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer," and Exchange Act Section 13(B)(2)(B) requires issuers to devise and maintain an adequate system of internal accounting controls. 15 U.S.C. § 78m(b)(2).
Guilford violated Exchange Act Section 13(a) and Rule 13a-13 because it filed with the Commission three periodic reports on Form 10-Q which contained materially misstated financial statements. Guilford also violated Exchange Act Section 13(b)(2)(A) and (B) because its books and records did not accurately and fairly reflect its transactions and dispositions, and because it failed to implement and maintain adequate internal accounting controls following its acquisition of Hofmann Laces. Guilford allowed a single individual to control access to Hofmann Laces' books and records without sufficient checks to ensure that his activities were proper, at a time when Guilford had not yet integrated the general ledger of Hofmann Laces into Guilford's existing system.
Based on the above, the Commission finds that Respondent Guilford Mills, Inc. violated Exchange Act Sections 13(a) and 13(b)(2)(A) and (B) and Exchange Act Rule 13a-13.
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Guilford Mills, Inc. cease and desist from committing or causing any violation of, and committing or causing any future violation of, Exchange Act Sections 13(a) and 13(b)(2)(A) and (B) and Exchange Act Rule 13a-13.
By the Commission.
Jonathan G. Katz
1 The findings herein are not binding on anyone other than Guilford.
2 In a separate civil action filed simultaneously with this proceeding, Timothy J. Gaffney consented to the entry of an order by the court pursuant to Section 21(d) of the Exchange Act enjoining him from future violations of the Exchange Act Section 10(b) and Rule 10b-5 and ordering him to pay a $25,000 civil penalty. SEC v. Timothy J. Gaffney, Civil Action No. 1:00CV01725 (RMU) (D.D.C., filed July 24, 2000).
3 Prior to August 1998, no one had access to Hofmann Laces' general ledger without Gaffney's knowledge and approval. The general ledger was kept in a fireproof safe in Gaffney's office.
4 The difference between Guilford's reported and restated operating income for the 3 affected quarters was less than the amount by which Gaffney overstated income at Hofmann Laces. This is because Guilford, in restating its operating income, recalculated and reduced certain incentive bonuses payable to officers and employees based on the lower actual earnings of the company.
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