UNITED STATES OF AMERICA
In the Matter of
AMERICAN CLASSIC VOYAGES CO.
|ORDER INSTITUTING |
TO SECTION 21C OF THE
SECURITIES EXCHANGE ACT
OF 1934, MAKING FINDINGS
AND IMPOSING A CEASE-
The Securities and Exchange Commission (Commission) deems it appropriate to institute cease-and-desist proceedings against Respondent American Classic Voyages Co. (American Classic) pursuant to Section 21C of the Securities Exchange Act of 1934 (Exchange Act).
In anticipation of the institution of these proceedings, American Classic has submitted an Offer of Settlement (Offer), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings 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, 17 C.F.R. §201.100 et seq., and without admitting or denying the Commission's findings contained herein, except to the Commission's jurisdiction over it and the subject matter of this proceeding, which are admitted, American Classic consents to the entry of this Order Instituting Proceedings Pursuant to Section 21C of the Exchange Act, Making Findings and Imposing a Cease-and-Desist Order (Order).
On the basis of the Order and American Classic's Offer, the Commission makes the following findings:
A. American Classic is a Delaware corporation with its corporate headquarters in Chicago, Illinois, and its operations based in New Orleans, Louisiana and Miami, Florida. American Classic is a provider of overnight passenger cruises. Its securities are registered with the Commission pursuant to Section 12(g) of the Exchange Act of and are traded on Nasdaq. During the relevant period, American Classic filed periodic and other informational reports with the Commission pursuant to Section 13(a) of the Exchange Act.
B. In May 1999, American Classic filed with the Commission a quarterly report on Form 10-Q for the three-month period ended March 31, 1999 (the first quarter 1999 Form 10-Q). The first quarter 1999 Form 10-Q was inaccurate and misleading in three material respects, all related to American Classic's decision to capitalize approximately $2.8 million in advertising costs, instead of expensing them as it had in previous periods. Advertising costs were a significant expense for American Classic, and the capitalization of these costs in the first quarter of 1999 reduced American Classic's net loss by 29%. First, the Management's Discussion and Analysis (MD&A) section of the first quarter 1999 Form 10-Q compared operating results for the first quarters of 1999 and 1998 without disclosing that the capitalization of advertising costs substantially improved reported results for the first quarter of 1999. Second, the financial statements in the first quarter 1999 Form 10-Q understated American Classic's net loss for the period by 29%, and understated its selling, general and administrative expenses, because the capitalization and deferral to later quarters of certain advertising costs deviated from generally accepted accounting principles (GAAP). Third, American Classic deviated from GAAP by failing to disclose in its first quarter 1999 Form 10-Q that it had changed accounting treatment for its advertising costs.
American Classic's MD&A Section
In the First Quarter 1999 Form 10-Q
C. In early 1999, American Classic was concerned that its accounting method of expensing its direct marketing costs as they were incurred did not accurately reflect its business, because these expenses generated revenues that were not recognized until later quarters. Specifically, the expenses associated with the direct marketing for particular cruises were not being matched with revenues being generated by those cruises.
D. On May 14, 1999, American Classic timely filed with the Commission its Form 10-Q for the first quarter of 1999, ended March 31, 1999, pursuant to Section 13(a) of the Exchange Act and Rule 13a-13 thereunder. For the first time in this Form 10-Q, American Classic capitalized advertising costs rather than expense such costs at the time they were incurred.
E. The financial statements in American Classic's Form 10-Q included an income statement for the first quarter of 1999, and a comparative income statement for the first quarter of 1998. American Classic's capitalization of advertising costs resulted in the deferral of approximately $2.8 million of advertising costs in its financial statements from the first quarter of 1999 into later quarters in 1999, and a corresponding increase in before-tax income in the first quarter of 1999. American Classic reported a loss of $4.5 million, or ($0.32) per share for the first quarter of 1999. Absent the capitalization of advertising costs, American Classic would have reported a loss of $6.3 million, or ($0.44) per share, materially larger than the $4.4 million loss, or ($0.31) per share, reported for the first quarter of 1998. Additionally, the deferral of direct response advertising costs into later quarters of 1999 decreased selling, general, and administrative ("SG&A") expense reported for the first quarter of 1999 by $2.8 million, from $16.7 million to $13.9 million. SG&A expense was $13.1 million for the first quarter of 1998.
F. Section 13(a) of the Exchange Act and Rule 13a-13 thereunder require issuers of registered securities to file quarterly reports with the Commission. The information contained in these reports must be accurate. See, e.g., SEC v. Savoy Industries, Inc., 587 F. 2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Item 303 of Regulation S-K requires that the MD&A section of a public company's interim reports contain, among other matters, information that is "necessary to an understanding of [the public company's] financial condition and results of operation." Specifically, the MD&A section must "identify any significant elements of the registrant's income or loss from continuing operations which do not arise from or are not necessarily representative of the registrant's ongoing business." Instruction 4 to Item 303(b) of Regulation S-K, 17 C.F.R. Sec. 229.303(b). In addition, Exchange Act Rule 12b-20 requires that quarterly and other required periodic reports contain further material information necessary to make the required statements made, in the light of the circumstances under which they were made, not misleading. American Classic's MD&A section in the Form 10-Q for the first quarter of 1999 was materially misleading because it compared operating results for the first quarters of 1999 and 1998, without disclosing that the results for the first quarter of 1999 were materially affected by the capitalization of advertising costs and the resulting deferral of $2.8 million in advertising costs into later quarters. Among other things:
1. American Classic stated that SG&A expense increased $0.8 million from the first quarter of 1998 to the same period in 1999, partially because of a $0.4 million increase in expansion costs. American Classic did not disclose that if the consistent method of expensing advertising costs as incurred was used in the two periods, SG&A expense would have increased $3.6 million, or 27.5%; and
2. American Classic stated that the consolidated operating loss (before tax) for the first quarter of 1999 was $6.3 million, only slightly more than the $6.1 million loss for the first quarter of 1998. However, American Classic did not disclose that, absent the capitalization of advertising costs, its operating loss (before tax) would have been $9.1 million, or 50% more than the comparable period in 1998.
American Classic Did Not Disclose the
Change in Accounting Treatment for Advertising Costs
G. Financial Statements contained in quarterly and annual reports filed with the Commission under Section 13(a) of the Exchange Act must conform to Regulation S-X, which in turn requires conformity with GAAP. In its quarterly and annual reports for 1998, American Classic had recorded advertising costs as expenses at the time they were incurred. American Classic disclosed this policy in its Form 10-K for the period ended December 31, 1998, filed with the Commission on March 31, 1999. American Classic's decision to capitalize advertising costs in 1999 was an accounting change that should have been disclosed in its Form 10-Q for the first quarter of 1999. See generally Accounting Principles Board (APB) Opinion No. 20; APB No. 28, ¶¶ 23 - 28. American Classic deviated from GAAP by failing to disclose this change.
American Classic's Failure to Meet the
Requirements of SOP 93-7 - "Reporting on Advertising Costs"
H. On December 29, 1993, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 93-7, "Reporting on Advertising Costs" (SOP 93-7), which was effective for financial statements for years beginning after June 15, 1994. SOP 93-7 is the authoritative accounting literature governing American Classic's accounting for its advertising costs. SOP 93-7, ¶ 26, requires that advertising costs generally be expensed either as they are incurred or the first time advertising takes place. SOP 93-7, however, contains an exception for certain direct-response advertising costs, which are costs of advertising whose primary purpose is to elicit sales to customers who can be shown to have responded specifically to the advertising. If an advertising cost falls within the exception, the costs should be capitalized. To fall within the exception, SOP 93-7 ¶ 34 requires:
there must be a means of documenting that response, including a record that can identify the name of the customer and the advertising that elicited the direct-response. Examples of such documentation include the following: files indicating the customer names and the related direct-response advertisement; a coded order form, coupon, or response card, included with an advertisement, indicating the customer name; and a log of customers who have made phone calls to a number appearing in an advertisement, linking those calls to the advertisement.
I. Further, to utilize the exception, SOP 93-7 requires that the advertising costs result in probable future economic benefits. Such benefits are defined to be "probable future revenues arising from that advertising in excess of future costs to be incurred in realizing those revenues." SOP 93-7, ¶ 36. SOP 93-7 discusses the conditions that must be met in order to conclude that direct-response advertising results in probable future benefits in ¶ 37:
Demonstrating that direct-response advertising will result in future benefits requires persuasive evidence that its effects will be similar to the effects of responses to past direct-response advertising activities of the entity that resulted in future benefits. Such evidence should include verifiable historical patterns of results for the entity. Attributes to consider in determining whether the responses will be similar include (a) the demographics of the audience, (b) the method of advertising, (c) the product, and (d) economic conditions.
J. SOP 93-7, ¶ 70, also requires that the estimate of future benefits be based on "reliable information." SOP 93-7 further states, "it is generally difficult to determine the probable future benefits of advertising with the degree of reliability sufficient to report the results of the advertising as assets." SOP 93-7, ¶ 70.
K. During 1998 and 1999, American Classic primarily advertised its cruises by mass mailing flyers and brochures to potential customers. In response to the mailings, potential customers made reservations for cruises by contacting American Classic. American Classic mailed most of its advertisements and incurred most of its advertising costs during the first quarter of the year to promote cruises in the summer and fall. During 1998, American Classic recorded its advertising costs at the time they were incurred and disclosed this policy in its Form 10-K. In the first quarter of 1999, however, American Classic decided to capitalize these costs, relying on the exception for direct response advertising costs. To capitalize direct-response advertising costs under the provisions of SOP 93-7, American Classic needed to have an effective means to demonstrate that the customers who purchased cruises had responded to specific advertisements. American Classic also had to demonstrate that its advertising costs were recoverable from future benefits arising from such advertising, i.e., future revenues from passenger cruises minus future costs to be incurred in realizing those revenues.
L. When American Classic filed its first quarter 1999 Form 10-Q, it was not determined whether American Classic had an effective means to demonstrate that the customers who purchased cruises responded to specific advertisements, nor were analyses performed to demonstrate the extent to which American Classic's advertising expenses were recoverable from probable future benefits. Absent this information, SOP 93-7 did not allow American Classic to capitalize direct-response advertising costs in the first quarter of 1999. As a result, the financial statements contained in the first quarter 1999 Form 10-Q deviated from GAAP, understated American Classic's net loss by 29%, and understated its SG&A expense by 17%.
American Classic's Rescission of its Change in
Accounting Treatment for Advertising Costs
M. After receiving notice of the staff's investigation, American Classic conducted a review of its advertising expenses and, on November 2, 1999, American Classic voluntarily rescinded its capitalization of advertising costs. In a Form 8-K, American Classic announced that it rescinded its capitalization of advertising costs and restated its earnings for the first and second quarters of 1999.
Violations of the Federal Securities Laws
N. On or about May 14, 1999, American Classic violated Section 13(a) of the Exchange Act and Rules 13a-13 and 12b-20 thereunder in that, as an issuer of a security registered pursuant to Section 12 of the Exchange Act, it filed a quarterly report, described in paragraphs II.B. through II.F. above, with the Commission containing information that was materially inaccurate and, in addition to the information expressly required to be included in the quarterly report, did not add such further material information as was necessary to make the required statements, in the light of the circumstances under which they were made not misleading, as described in paragraphs II.A. through II.M. above.
O. From in or about March 1999 through on or about May 14, 1999, American Classic violated Section 13(b)(2)(A) of the Exchange Act in that, as an issuer which has a class of securities registered pursuant to Section 12 of the Exchange Act and which was required to file reports pursuant to Section 15(d) of the Exchange Act, American Classic made and kept books, records and accounts which, did not, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer, as described in paragraphs II.A. through II.M. above.
In view of the foregoing, the Commission deems it appropriate to impose the sanction set forth in the Offer submitted by American Classic.
Accordingly, IT IS HEREBY ORDERED that pursuant to Section 21C of the Exchange Act, American Classic cease and desist from committing or causing any violation and any future violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder.
By the Commission.
Jonathan G. Katz
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