U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

United States of America
before the
Securities and Exchange Commission

Release No. 45393 / February 5, 2002

Release No. 1503 / February 5, 2002

File No. 3-10693

In the Matter of


The Securities and Exchange Commission deems it appropriate that public administrative proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Critical Path, Inc. committed or caused violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rule 13a-13 thereunder.


In anticipation of the institution of these administrative proceedings, Critical Path has submitted an Offer of Settlement ("Offer") that the Commission has determined to accept. Solely for purposes of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings contained herein, except as to jurisdiction over it and over the subject matter of these proceedings, which Critical Path admits, Critical Path consents to the entry of this Order Instituting Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Imposing a Cease-and-Desist Order ("Order"). In determining to accept the Offer, the Commission considered remedial acts promptly undertaken by Critical Path and cooperation afforded the Commission staff.


Based on the foregoing, the Commission finds:1

A. Respondent

Critical Path, Inc. is a California corporation with principal offices in San Francisco. From its initial public offering in March 1999 to the present, Critical Path's common stock has been registered with the Commission pursuant to Section 12(g) of the Exchange Act and has been quoted on the Nasdaq Stock Market. The company is a provider of Internet messaging infrastructure products and services.

B. Summary

For two successive fiscal quarters in late 2000, Critical Path materially overstated its revenue, and materially understated its loss, in contravention of Generally Accepted Accounting Principles (GAAP). The company filed materially incorrect financial statements with the Commission for the third quarter of fiscal 2000 (ended September 30, 2000). On January 18, 2001, Critical Path issued a press release containing materially incorrect statements of operations and financial position for the fourth quarter and the year 2000. Certain Critical Path managers, including its president, its sales chief and others, caused this incorrect recording of revenue by creating spurious sales contracts, hiding contingencies affecting revenue recognition, and backdating software license agreements.

Critical Path's finance department uncovered improper practices before incorrect fourth quarter and annual financial statements were filed with the Commission. The company's board of directors conducted an internal investigation, fired the wrongdoers, hired a new management team, and improved internal controls. On April 5, 2001, Critical Path restated its financial results for the third quarter and revised results for the fourth quarter and full year 2000.

C. Background and Critical Path's Forecast of Profitability For the Fourth Quarter of 2000

Critical Path was founded in 1997. Its business plan was to provide e-mail software and services to companies that wished to outsource that function. In 1998 Critical Path had revenue of $897,000 and lost $11.4 million. Three months into 1999, the company went public. During the next year, Critical Path used its stock and the cash from the IPO to buy a number of companies with related technology. This enabled Critical Path to offer a suite of products and become the leader in the nascent outsourced e-mail and messaging market. But like many Internet companies, Critical Path was not making a profit.

After reporting revenue of $16.1 million for the year ended December 31, 1999, the company reported revenue of $24.6 million in the first quarter of 2000 alone. The next quarter revenue jumped to $33.5 million, beating consensus revenue estimates by almost $6 million. Critical Path reported a net loss for the second quarter (excluding special charges) of $20.2 million, or thirty-four cents per share, but beat consensus earnings-per-share estimates by two cents. When Critical Path's CEO announced second quarter results to analysts on July 19, 2000, he predicted that for the fourth quarter of 2000 Critical Path would, for the first time, report a profit, excluding special charges. Critical Path had publicly set itself the task of moving from a $20.2 million quarterly net loss to profitability in just two quarters.

D. Third Quarter 2000: Critical Path Overstates Revenue and Understates Loss

As the third quarter drew to a close, the company was short of meeting its revenue and earnings goals. To meet consensus earnings estimates by analysts who followed the company, Critical Path's president engaged in or oversaw several transactions that the company should not have reported, but did report, as revenue on its third quarter Form 10-Q.

The largest misstated transaction involved a barter transaction with a business software company. On September 28, 2000, the software company agreed to buy out a periodic royalty obligation2 for $2.8 million and buy another $240,000 of software; in exchange, Critical Path's president signed an agreement obligating Critical Path to buy about $4 million of software and services from the software company, $2.6 million more than Critical Path was set to purchase just days before. To recognize revenue from such a barter transaction in conformity with GAAP, Critical Path needed to establish the fair value of either the software it received from or the software it sent to the software company, and the value ascribed to the software Critical Path was receiving had to reasonably reflect Critical Path's expected use of the software.3 Although these requirements were not satisfied, Critical Path recorded a $3.09 million sale to the software company as revenue for the third quarter. After completing the internal investigation and annual audit, Critical Path permanently reversed the entire $3.09 million.

Another misstated transaction involved a $536,000 contract with an Internet portal company. Critical Path's president agreed to extend payment terms well beyond the company's standard payment terms. In an attempt to evade Critical Path's internal controls and the scrutiny of the company's independent accountants, he put the extension in a side letter and did not provide it to the finance department. Under GAAP, extended payment terms raise various concerns and can prevent a sale from being immediately recognized as revenue.4 Critical Path included the revenue from this transaction in its third quarter financial statements. After completing the internal investigation and annual audit, Critical Path reversed the entire $536,000 amount for several reasons, including the side letter granting extended payment terms, with plans to recognize the revenue in a later period.

Critical Path did not have internal accounting controls sufficient to ensure that all elements of SOP 97-2 were satisfied before a software license agreement was recorded as revenue. After the end of the third quarter, Critical Path's European division recorded as third quarter sales three software license transactions valued at a total of $1.395 million. The company included the revenue from the three sales in its third quarter financial statements. In the restatement, Critical Path reversed this revenue and recognized it in the fourth quarter because persuasive evidence of an arrangement-as required by SOP 97-2-did not exist in the third quarter.

By including in third quarter revenue these five later-restated transactions, Critical Path exceeded consensus earnings estimates for the quarter. On October 19, 2000, Critical Path announced third quarter revenue of $45 million and a loss of fourteen cents per share (excluding special charges). On November 14, 2000, the company filed financial statements with the Commission for the quarter ended September 30, 2000, that improperly included revenue from the later-restated transactions.

E. Fourth Quarter 2000: Critical Path Issues Press Release Overstating Revenue and Understating Loss For Fourth Quarter and Year 2000

In October 2000, Critical Path's CEO publicly stated that the company was increasing its fourth quarter revenue estimate from $54 million to $56 million and reiterated his earlier prediction that the company would earn its first quarterly profit-one cent per share. On November 2, Critical Path issued a press release reiterating that guidance.

In December 2000, the company was in a race to close sales and reduce costs before the end of the month so that it could announce a profit for the quarter as promised. In the final week, Critical Path's president and its sales chief concluded there were no legitimate means by which Critical Path could achieve the ambitious revenue and earnings goals the company had announced. The president told the sales chief to get approximately $4 million in "back pocket" deals and assured him that Critical Path could use its bad debt reserve to absorb the losses when the purported customers failed to pay.

Because Critical Path's finance department required that at least an evaluation agreement be signed by a potential customer before it would ship software, the sales chief instructed the sales force to secure all possible deals (whether real or not) at least to the point of getting an evaluation agreement so that software could be shipped. The plan was to get final agreements signed at some later date, and to backdate them if necessary.

The result of this plan was the recording of revenue from three $2 million spurious or contingent transactions and three smaller backdated agreements. As those carrying out the plan at Critical Path and the customers' representatives knew, in two of these $2 million transactions the customers had no intention of buying the software. The third transaction-a $2.221 million software license agreement with a company that provides Internet access to schools-was accompanied by two secret side letters that allowed the company to void the transaction at its sole discretion. After completing the internal investigation, Critical Path permanently reversed the entire $6.35 million from these three transactions.

After the end of the year, Critical Path employees closed and backdated three sales agreements valued at a total of $825,000. Critical Path included these sales in the fourth quarter results it initially announced. In the restatement, Critical Path moved the revenue to the first quarter of 2001.

On January 11, 2001, Critical Path's president directed Critical Path personnel to backdate to December a $750,000 sale just made to a multimedia software company. In addition, the company planned to recognize a $7 million sale to a firm-ostensibly a value-added reseller-that was formed for this transaction and was owned by a group that owned a substantial amount of Critical Path stock. With the revenue from these transactions, Critical Path would beat consensus estimates for revenue-but not earnings-for the quarter.

On about that day, however, a Critical Path finance officer disclosed the backdating of the $750,000 multimedia software company contract to Critical Path's new CFO.5 The new CFO corrected the contract date and did not allow the revenue to be recorded in the fourth quarter. On January 17, Critical Path's independent accountants told the new CFO that the company should not record as revenue the $7 million transaction with the reseller because, in its view, both the reseller and the business objectives of the transaction lacked substance. Critical Path agreed not to record the revenue.

Critical Path had failed to meet revenue estimates for the quarter despite including in quarterly revenues additional transactions that were later revised. After the market closed on January 18, 2001, Critical Path announced unaudited condensed consolidated operating results for the fourth quarter and year 2000 "prepared and presented in accordance with generally accepted accounting principles." Even though the announced results for the fourth quarter were materially overstated, they were below consensus estimates for both revenue and earnings. Critical Path had forecast a one cent per share profit on revenue of $54 to $56 million. It now reported a loss of $11.5 million for the quarter, or sixteen cents per share, on revenue of $52 million. On the news of the missed quarterly estimates, Critical Path's stock price plummeted. By the close of the first full day of trading after the announcement, it had dropped 55%, from $20 to $9.

F. January 31, 2001: The Plan Is Discovered

On January 31, 2001, Critical Path's new CFO learned about the misconduct and alerted the company's board, which held an emergency meeting on February 1. The board took a number of steps, including forming a special committee to conduct an investigation and placing the company's president and sales chief on administrative leave. The company's independent auditors were also alerted.

On February 2, before the market opened, Critical Path issued a press release disclosing that its board had formed a special committee to conduct an investigation into the company's revenue recognition practices, and that it now believed that the results the company announced on January 18 might have been materially misstated. Nasdaq suspended trading in the stock before the market opened pending the company's release of accurate financial results. Trading resumed on February 15 after the company announced, on a preliminary basis, that it would revise its fourth quarter revenue downward by $6.5 to $8 million, and that approximately $4.2 million of the revision would involve transactions that would never result in revenue. That day Critical Path's share price closed at $3.06, a decline of approximately 70% from $10.06, the last Nasdaq price before the trading halt.

On April 5, 2001, Critical Path filed its Form 10-K for fiscal 2000. The following table compares the originally reported or announced financial results with the restated or revised results:

Line Item As Originally Released As Restated or Revised % Original Was Over- or Understated

3rd Quarter 2000 Revenues




3rd Quarter 2000 Net Loss




4th Quarter 2000 Revenues




4th Quarter 2000 Net Loss




Fiscal 2000 Revenues




Fiscal 2000 Net Loss6




Legal Discussion

A. Critical Path Violated the Periodic Reporting Provisions of the Exchange Act

Section 13(a) of the Exchange Act requires issuers to file such annual and quarterly reports as the Commission may prescribe and in conformity with such rules as the Commission may promulgate. Rule 13a-13 requires the filing of quarterly reports that comply with the Commission's Regulation S-X, which requires that financial statements be presented in conformity with GAAP.

As described above, the Form 10-Q filed by Critical Path for the third fiscal quarter of 2000 (ended September 30, 2000), contained financial statements that were not presented in conformity with GAAP. Consequently, Critical Path violated Section 13(a) of the Exchange Act and Rule 13a-13 thereunder.

B. Critical Path Violated the Record-Keeping and Internal Controls Provisions of the Exchange Act

Section 13(b)(2)(A) of the Exchange Act 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." Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit the preparation of financial statements in conformity with GAAP and to maintain the accountability of assets.

Critical Path's books and records contained extensive false and misleading entries relating to, among other things, spurious, contingent, and backdated software license agreements, and so did not fairly and accurately reflect the company's sales and receivables. Critical Path therefore violated Section 13(b)(2)(A).

Critical Path also violated Section 13(b)(2)(B). Company management did not devise a sufficient system of internal accounting controls or enforce the control procedures that were in place.


On the basis of this Order and the Offer of Settlement submitted by the Respondent, the Commission finds that Critical Path violated Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rule 13a-13 thereunder.


Accordingly, IT IS HEREBY ORDERED, effective immediately, that Critical Path, pursuant to Section 21C of the Exchange Act, cease and desist from committing or causing any violations and any future violations of Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act and Rule 13a-13 thereunder.

By the Commission.

Jonathan G. Katz


1 The findings herein are made pursuant to the Respondent's Offer and are not binding on any other person or entity in this or any other proceeding.

2 At the end of the second quarter 2000, the business software company had contracted to pay $500,000 for a source code license for one of Critical Path's applications, which the other software company planned to bundle with its own products. Under the arrangement the other software company was also to pay certain royalties to Critical Path based on the other software company's future sales of the bundled product. The other software company also had an option to buy out the future royalty obligation for $3 million.

3 Accounting Principles Board Opinion No. 29, Accounting for Non-monetary Transactions; American Institute of Certified Public Accountants (AICPA) Technical Practice Aid 5100.47. An exchange between the parties of a barter transaction of offsetting monetary consideration, such as a swap of checks for equal amounts, does not evidence the fair value of the transaction. Emerging Issues Task Force 99-17, Accounting for Advertising Barter Transactions, paragraph 4.

4 GAAP generally requires that software revenue be recorded in conformity with Statement of Position 97-2, Software Revenue Recognition, issued by the Accounting Standards Executive Committee of the AICPA. Paragraph 8 of SOP 97-2 states that if the arrangement to deliver software does not require significant production, modification, or customization of software, revenue should be recognized when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the vendor's fee is fixed or determinable, and (iv) collectibility is probable.

5 Although his predecessor had left the company in November 2000, the new CFO did not report for work until January 3, 2001.

6 Excludes special charges.



Modified: 02/05/2002