UNITED STATES OF AMERICA
In the Matter of
RACHEL ECKHAUS, CPA,
|ORDER INSTITUTING PUBLIC ADMINSTRATIVE PROCEEDINGS PURSUANT TO RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE AND FINDINGS AND ORDER OF THE COMMISSION|
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be and hereby are instituted against Rachel Eckhaus ("Eckhaus" or "Respondent") pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice1 to determine whether Eckhaus engaged in improper professional conduct.
In anticipation of the institution of this administrative proceeding, Respondent has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purposes of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the Commission's findings contained herein, except that she admits the jurisdiction of the Commission over her and over the subject matter of this proceeding, Respondent consents to the entry of this Order and the findings and imposition of remedial sanctions set forth below.
On the basis of this Order and the Respondent's Offer of Settlement, the Commission makes the following findings:2
Rachel Eckhaus is a certified public accountant licensed in New York. She joined Fine Host as Assistant Controller in March 1995 and resigned in February 1997.
Fine Host Corporation is a Connecticut-based company that, at all times relevant to this Order, provided food and beverage concession, catering and other services to approximately 400 facilities in 38 states. Fine Host conducted an initial public offering in June 1996, and a secondary offering in February 1997. Its stock was registered with the Commission under Section 12(g) of the Exchange Act and listed for trading on the Nasdaq National Market System. On January 7, 1999, subsequent to the extensive restatement of its financial statements, Fine Host entered a proceeding under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to its plan of reorganization, Fine Host has now become a private entity.
Fine Host Corporation engaged in an extensive financial fraud that, when detected, resulted in the collapse of its stock price and, eventually, the end of its existence as a public company. The scheme predated Fine Host's June 1996 initial public offering by several years and continued through the third quarter of the fiscal year ended December 31, 1997. It involved, as its primary mechanism, the improper capitalization of millions of dollars of Company expenses as assets. Fine Host also manipulated acquisition reserve accounts, income from vendor rebates, and other items for the purpose of managing reported earnings.
Based on an internal investigation, Fine Host issued a restatement of its financial statements in February 1998, reflecting that from 1992 through the third quarter of fiscal year 1997, Fine Host had overstated its pretax income by over $49 million. For fiscal years 1994, 1995 and 1996, Fine Host had overstated pretax income by 149%, 213%, and 197%, respectively.
Because Fine Host did not have a controller, Eckhaus, as Fine Host's Assistant Controller, was assigned responsibility to assist the CFO in preparing the Company's financial statements. As directed by her superiors, she participated in the preparation of financial statements that she knew or, in the exercise of reasonable care, should have known, were not in conformity with generally accepted accounting principles ("GAAP"). This conduct constituted improper professional conduct for purposes of Commission Rule of Practice 102(e).
Fine Host's Fraudulent Accounting Practices
Fine Host's improper accounting for "contract rights"
Fine Host's operations were based on securing contracts to provide food services to sports arenas, schools, convention centers, and other facilities. Beginning when Fine Host was a private company, its accounting practice was to aggregate certain costs associated with the pursuit of those contracts in an "acquisition costs" account. When a contract was signed, the costs attributed to it were then transferred to the "contract rights" account and were treated as capitalized costs to be amortized over the term of the contract.3
This practice was permissible under GAAP only to the extent these costs were directly related to the acquisition of assets with a future economic benefit to Fine Host. In practice, however, Fine Host routinely and improperly allocated a pool of general and administrative ("G&A") expenses to the contract rights account, without any documentary support for this practice, rather than properly recognizing these overhead costs as period expenses. Each quarter, Fine Host assigned a certain (arbitrarily determined) percentage of total costs to each facility. Fine Host then allocated costs to specific facilities by multiplying the total costs for the quarter by the facility's assigned percentage.
These improper accounting practices predated Eckhaus's employment with Fine Host. However, after she was hired by the Company in March 1995, Respondent shared responsibility for preparing Fine Host's financial statements for the fiscal year ended December 27, 1995.4 She soon became aware that the Company's accounting for the costs of contract acquisitions was not in conformity with GAAP but nevertheless continued to improperly account for these costs.
It was Eckhaus's responsibility to provide information to auditors from Deloitte & Touche ("Deloitte") in connection with their 1995 year-end audit of the Company's financial statements. Nevertheless, neither she nor her superiors informed the Deloitte auditors that the Company was improperly capitalizing overhead expenses as contract rights.
Fine Host's improper treatment of contract acquisition costs in the period preceding its IPO was material. In its restatement, Fine Host wrote-off $2,458,000 of such costs as improperly capitalized in 1994, representing approximately 75% of pretax income for the year. For 1995, Fine Host wrote-off $4,284,000 in contract acquisition costs, approximately 113% of pretax income for the year.
Fine Host's Improper Accounting for Acquisition Reserves
Fine Host regularly acquired other companies in the food services industry. These acquisitions provided another vehicle to manipulate Fine Host's earnings. For each acquisition, Fine Host would set up goodwill and an acquisition reserve. These reserves were then used as a "cookie jar" to offset losses on a purely discretionary basis, sometimes two or three years after the acquisition In many instances, Fine Host did not discontinue any activity in connection with these acquisitions, or incur costs related to these acquisitions, such as those for terminated employees. Typically, little (if any) documentation supported the amount taken as a reserve.
The Fine Host IPO
Fine Host filed the registration statement for its IPO on March 29, 1996. In its Form S-1, the Company reported results of operations for the fiscal years 1993 through 1995. Respondent assisted Fine Host's chief financial officer in the preparation of the financial information contained in the registration statement.
The staff of the Commission's Division of Corporation Finance reviewed the registration statement and commented upon it in detail. Although not a direct participant, Respondent was aware of the communications between the Company and the Commission staff. The staff specifically questioned Fine Host's accounting policy for contract rights. In response, Fine Host represented that, for all periods after year-end 1995, it would capitalize only two categories of costs associated with contract acquisitions: direct payments made to clients to acquire the contracts and the direct costs of obtaining licenses and permits to operate its contract locations. Fine Host specifically represented that it would no longer capitalize commissions and proposal costs. Finally, Fine Host represented that it had not amended its financial statements for the years covered by the registration statement to conform to this policy "since the impact of this adjustment would not be material for any year presented." In fact, as noted above, the misstatement of Fine Host's financial results due to improper capitalization of contract rights was material for each fiscal year 1993 through 1995.
The Fine Host registration statement became effective on June 19, 1996, with net proceeds to the Company of $32 million. As noted above, the 1994 and 1995 year-end financial statements contained in the registration statement were materially false and were subsequently restated.
The Fiscal Year Ended December 25, 1996
Following the IPO, while Respondent oversaw aspects of its internal accounting, Fine Host improperly continued to spread G&A expenses among its capitalized "contract rights." The aggregate "contract rights" balance increased every quarter in fiscal year 1996. In fiscal year 1996, additions to contract rights totaled $12.2 million, while the additions to the fixtures and equipment account approximated $16.5 million.
The items capitalized went well beyond both the cost categories Fine Host had represented to the Commission staff it would capitalize in the future and the capitalized cost categories it represented in its 1996 Form 10-K. In Fine Host's restatement, $6.3 million of capitalized 1996 contract acquisition costs were reversed as improper. This represented approximately 98% of Fine Host's pretax income for the entire year.
During 1996, Fine Host also became increasingly aggressive about misuse of acquisition reserves. Fine Host improperly lowered its expenses by offsetting $2.65 million in operating expenses against previously recorded acquisition reserves. This inflated Fine Host's pre-tax income by 41%.
By the autumn of 1997, amortization of Fine Host's growing contract rights balance was reducing reported earnings, and Fine Host was experiencing increasing difficulty in meeting analysts' expectations. Alerted by a member of management that certain of the Company's accounting practices were questionable, the independent directors initiated an internal investigation. In February 1998, at the conclusion of this investigation, Fine Host announced that it had overstated its pre-tax net income by $49 million, from approximately 1992 through the third quarter of 1997.
In Fine Host's restatement, eighteen categories of material accounting errors were identified, with improperly capitalized contract rights of $21.7 million being the largest. Acquisition reserves totaling $8.4 million were written off because (i) they were costs that should have been expensed as incurred, (ii) the Company lacked documentation linking them to a particular acquisition or (iii) the reserve, when properly decreased, already had been exhausted. In addition, Fine Host wrote off purported rebates receivable in the amount of $5.5 million, because they were supported by little, if any, documentation.
On January 7, 1999, Fine Host entered a proceeding under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to its plan of reorganization, Fine Host has now become a private entity.
Eckhaus Engaged in Improper Professional Conduct for Purposes of Commission Rule of Practice 102(e)
Eckhaus assisted Fine Host's chief financial officer by preparing financial statements, which did not conform to GAAP, to be included in the Company's filings; by maintaining false and misleading books and records; and by failing to maintain a system of internal accounting controls sufficient to prevent the recording of improper adjustments. Eckhaus also failed to provide the Company's auditors with information known to her that would have alerted them to the Company's accounting fraud. Her disregard for her professional responsibilities allowed the Company to continue its financial fraud for an extended period and constituted improper professional conduct.
Based upon the foregoing, the Commission finds that Rachel Eckhaus engaged in improper professional conduct for purposes of Rule 102(e)(1) of the Commission's Rules of Practice.
IT IS HEREBY ORDERED, effective immediately, that:
Rachel Eckhaus be, and hereby is, denied the privilege of appearing or practicing before the Commission as an accountant. After two (2) years from the date of this Order, Eckhaus may request that the Commission consider her reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as:
1. A preparer or reviewer, or a person responsible for the preparation or review, of any public company's financial statements that are filed with the Commission. Such an application must satisfy the Commission that Eckhaus's work in her practice before the Commission will be reviewed either by the independent audit committee of the public company for which she works or in some other acceptable manner, as long as she practices before the Commission in this capacity; and/or
2. An independent accountant. Such an application must satisfy the Commission that:
a. Eckhaus, or any firm with which she is or becomes associated, is a member of the SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms ("SEC Practice Section");
b. Eckhaus, or the firm, has received an unqualified report relating to her or the firm's most recent peer review conducted in accordance with the guidelines adopted by the SEC Practice Section; and
c. As long as Eckhaus appears or practices before the Commission as an independent accountant, she will remain either a member of the SEC Practice Section or associated with a member firm of the SEC Practice Section, and will comply with all applicable SEC Practice Section requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education.
The Commission's review of any request or application by Eckhaus to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Eckhaus's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
Jonathan G. Katz
|1|| Rule 102(e)(1) of the Commission's Rules of Practice provides in pertinent part that:
The Commission may censure a person or deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice and opportunity for hearing in the matter: . . . (ii) to have engaged in unethical or improper professional conduct.
|2||The findings herein are made pursuant to the respondent's Offer of Settlement and are not binding on any other person or entity in this or in any other proceeding.|
|3||In addition, substantial amounts of these costs were improperly capitalized in "fixtures and equipment" accounts, particularly in 1996 and 1997.|
|4||At that time, Fine Host was preparing for its IPO. The 1995 financial statements were the latest annual financial statements included in the offering documents.|
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