UNITED STATES OF AMERICA
In the Matter of
|ORDER INSTITUTING PUBLIC PROCEEDINGS PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS, AND IMPOSING A CEASE-AND- DESIST ORDER|
The Commission deems it appropriate to institute public administrative proceedings against Advanced Technical Products, Inc. ("ATP"), James S. Carter, and Garrett L. Dominy (collectively "the Respondents") pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), and such proceedings are hereby instituted.
In anticipation of the institution of these proceedings, each of the Respondents has submitted an Offer of Settlement that 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 to which the Commission is a party, and without admitting or denying the Commission's findings contained in this Order, except that the Respondents each admit that the Commission has jurisdiction over them and over the subject matter of this proceeding, the Respondents each consent to the entry of this Order.
The Commission finds that:1
In May 2000, ATP restated its financial results for its fiscal year ended December 31, 1998 (including all interim quarters) and for the first three quarters of its fiscal year ended December 31, 1999. The restatement was required because of a massive financial fraud orchestrated by senior management of one of ATP's wholly owned subsidiaries, Alcore, Inc. Among other things, Alcore's senior officers-one of whom was also an officer of ATP-materially overstated revenues and assets, materially understated expenses, and falsified corporate books and records. This misconduct went undetected and uncorrected in large part because ATP failed to devise and maintain adequate internal accounting controls and because Alcore personnel circumvented the controls that did exist. The fraud at Alcore caused ATP to file with the Commission six quarterly reports on Form 10-Q and one annual report on Form 10-K that materially misstated the company's consolidated financial results throughout the relevant period. It also caused ATP's books and records to be materially inaccurate throughout the relevant period.2
Moreover, during the period of the fraud being perpetrated at the Alcore subsidiary, ATP's management―in particular its Chief Executive Officer (Respondent Carter) and Chief Financial Officer (Respondent Dominy)―failed to take adequate corrective action in the face of several red flags suggesting a failure of internal controls and possible accounting irregularities at Alcore. As a result, the fraud at Alcore continued until January 2000, when the FBI served Alcore with a search warrant for corporate financial records.
Advanced Technical Products, Inc. ("ATP") is a Delaware corporation headquartered in Roswell, Georgia. Through its operating subsidiaries, ATP designs, develops, and manufactures materials and products used in aerospace and defense equipment. ATP's stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and trades on the Nasdaq National Market. At all relevant times, Alcore, Inc. was one of ATP's five operating subsidiaries, and was wholly owned by ATP. During the relevant period, Alcore primarily designed and manufactured airplane components at several facilities located in Maryland, and accounted for a substantial portion of ATP's consolidated revenues and net income. After the events described herein, ATP sold most of the assets of its Alcore subsidiary to another company and liquidated the remaining assets.
James S. Carter, age 67, is a resident of Atlanta, Georgia. Carter was ATP's President and Chief Executive Officer ("CEO"), and Chairman of its board of directors, during the relevant period. He resigned from the positions of President and CEO effective March 30, 2000, and from the position of Chairman effective June 30, 2000, but remains a member of ATP's board of directors. During the relevant period, Carter owned between 5% and 6% of ATP's outstanding common stock.
Garrett L. Dominy, age 57, is a resident of Atlanta, Georgia. A certified public accountant, Dominy was ATP's Executive Vice President, Chief Financial Officer ("CFO"), Treasurer, and Assistant Secretary, as well as a member of ATP's board of directors during the relevant period. Effective March 30, 2000, he succeeded Carter as ATP's President and CEO, and in May 2000 he relinquished his duties as Executive Vice President, CFO, Treasurer, and Assistant Secretary. Dominy continues to serve as ATP's President and CEO, and as a member of its board of directors. During the relevant period, Dominy owned approximately 3% of Alcore's outstanding common stock.
C. The Fraud at Alcore
Throughout ATP's 1998 and 1999 fiscal years, personnel at the company's Alcore subsidiary-led by certain members of Alcore's senior management-engaged in a massive financial fraud through which ATP's consolidated assets and earnings were materially overstated. As a result, the financial statements included in ATP's quarterly reports on Form 10-Q for the first, second and third quarters of both its 1998 and 1999 fiscal year, and in its annual report on Form 10-K for its 1998 fiscal year, were materially false and misleading and did not comply with generally accepted accounting principles. The financial fraud at Alcore involved the systematic understatement of expenses and overstatement of assets and revenues, and was achieved primarily by improperly capitalizing expenses, improperly and prematurely recognizing revenue, overvaluing inventory, and understating costs of goods sold. The scheme stopped only when, on January 7, 2000, the FBI served Alcore with a search warrant for financial records.
Several months later, as a direct result of the fraud at Alcore, ATP restated its financial statements for the 1998 fiscal year (including each fiscal quarter of the year) and for the first three quarters of its 1999 fiscal year. The cumulative impact of the restatement-as the table below reflects-was to reduce ATP's net income for its 1998 fiscal year from $5,687,000 (as originally reported) to $3,999,000 (as restated), and its net income for the first three quarters of its 1999 fiscal year from $4,906,000 (as originally reported) to a net loss of $229,000 (as restated):
1998 Fiscal Year
|($$ in 000's)||1st Quarter||2nd Quarter||3rd Quarter||4th Quarter||Total Year|
|Originally Reported Net Income||111||1,302||1,949||2,325||5,687|
|Restated Net Income||102||1,230||1,214||1,453||3,999|
1999 Fiscal Year - First Three Quarters
|($$ in 000's)||1st Quarter||2nd Quarter||3rd Quarter||Total Three Quarters|
|Originally Reported Net Income||1,108||1,961||1,837||4,906|
|Restated Net Income||186||513||(928)||(229)|
Thus, approximately 30% of ATP's reported earnings for fiscal year 1998 were overstated, and approximately 105% of its reported earnings for fiscal year 1999 were overstated. After ATP disclosed the accounting problems at Alcore in early 2000, and ultimately quantified the necessary restatements in May 2000, ATP's stock price steadily plummeted from $14 per share in early January to less than $2 per share in August 2000.
D. Carter's and Dominy's Conduct
During the relevant period, the fraud at Alcore became so widespread that certain signs of it could not be concealed from management of ATP, Alcore's parent company. However, ATP management―in particular Respondents Carter and Dominy―failed to take adequate corrective action in the face of red flags that suggested a failure of internal controls and possible accounting irregularities at Alcore. As a result, the company continued to file periodic reports with the Commission, and provided documentation to a potential buyer of the company,3 that included financial statements which ATP's management knew or should have known had a high probability of material misstatement.
For example, in July 1999, Carter and Dominy learned that a former Alcore employee had called one of ATP's outside directors and alleged improprieties in Alcore's accounting practices-a complaint that ultimately proved well-founded. Carter and Dominy failed to take appropriate follow-up action to determine the validity of this allegation. Carter and Dominy also took no definitive action to remedy problems that ATP's Controller specifically identified for them in a series of monthly memoranda throughout the second and third quarters of 1999 relating to Alcore's financial statements and reports. In July 1999, the Controller wrote that Alcore's "balance sheet classifications are in disarray . . . [with] prepaids, accounts payable and accrued expenses . . . apparently out of whack[,] possibly leading to inventory or [profit and loss] misstatements." The Controller's July 1999 memo further noted an increase in Alcore's prepaid assets account that "doesn't make sense," giving the appearance that Alcore had simply "plugged [the] account by $550[,000] to balance for the month." In his August 1999 memo, the Controller observed that Alcore "admittedly [is] deferring some costs to help boost current earnings"; and in September 1999, he wrote that Alcore's "balance sheet classification problems noted in previous months continue[,] with prepaids, cash, accounts payable and accrued expenses all contain[ing] some level of misstatement." Similarly, the Controller's July and September 1999 memoranda reflect that the same purported "system implementation problems" that Alcore claimed were causing distortions of its accounts payable and prepaid balances remained uncorrected for months.
In October 1999, after the close of the third quarter of ATP's 1999 fiscal quarter but before the company filed its quarterly report on Form 10-Q with the Commission, Carter and Dominy also learned information about four specific Alcore sales during the quarter (totaling more than $500,000) from which Dominy concluded that the sales should not have been recorded as revenue. Instead of thoroughly investigating the matter, however, Carter and Dominy accepted Alcore management's assurances that there were no other improperly recognized sales at Alcore. They also determined to offset the improperly recorded sales against certain expenses they believed could have been capitalized during the quarter, and thus did not reverse the improperly recognized sales before filing the company's quarterly report on Form 10-Q several weeks later.
E. Legal Analysis
Exchange Act Section 13(a) and Exchange Act Rules 13a-1 and 13a-13 require issuers of registered securities to file annual and quarterly reports with the Commission. Exchange Act Rule 12b-20 requires that these periodic reports contain all material information necessary to make the required statements not misleading. The filing of a periodic report containing materially false or misleading information constitutes a violation of these provisions. SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978). Exchange Act Section 13(b)(2)(A) requires issuers of registered securities to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets. Exchange Act Section 13(b)(2)(B) requires such issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that its transactions were recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles. Exchange Act Section 13(b)(5) provides that no person shall, among other things, knowingly fail to implement a system of internal accounting controls.
As described above, ATP failed to devise and maintain effective internal accounting controls in violation of Exchange Act Section 13(b)(2)(B). This failure allowed officers and employees of ATP's Alcore subsidiary to perpetrate a two-year financial fraud that caused ATP to maintain materially inaccurate books, records, and accounts in violation of Exchange Act Section 13(b)(2)(A), and to file periodic reports with the Commission that included materially false and misleading financial statements in violation of Exchange Act Section 13(a) and Exchange Act Rules 12b-20, 13a-1, and 13a-13. In particular, the assets and earnings ATP reported in its quarterly reports on Form 10-Q for each quarter of both its 1998 and 1999 fiscal years, and in its annual report on Form 10-K for its 1998 fiscal year, were materially overstated. Moreover, by failing to take appropriate remedial action in the face of red flags suggesting a failure of internal controls and possible accounting irregularities at Alcore, Carter and Dominy violated Exchange Act Section 13(b)(5) and were causes of ATP's violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and Exchange Act Rules 12b-20, 13a-1, and 13a-13.
Based on the foregoing, the Commission finds that:
(a) ATP violated Exchange Act Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13;
(b) Carter violated Exchange Act Section 13(b)(5) and was a cause of ATP's violations of Exchange Act Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13; and
(c) Dominy violated Exchange Act Section 13(b)(5) and was a cause of ATP's violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13.
Accordingly, IT IS HEREBY ORDERED, pursuant to Exchange Act Section 21C, that:
(a) ATP cease and desist from committing or causing any violation and any future violation of Exchange Act Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13;
(b) Carter cease and desist from committing or causing any violation and any future violation of Exchange Act Section 13(b)(5), and from causing any violation and any future violation of Exchange Act Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13; and
(c) Dominy cease and desist from committing or causing any violation and any future violation of Exchange Act Section 13(b)(5), and from causing any violation and any future violation of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B), and Exchange Act Rules 12b-20, 13a-1, and 13a-13.
By the Commission.
Jonathan G. Katz
|1||The findings herein are not binding on anyone other than the Respondents.|
|2||On July 23, 2001, the Commission sued Alcore's former Chief Executive Officer and former Chief Financial Officer for their participation in the financial fraud at Alcore. SEC v. Edward J. Kiley and Richard N. Orzechowski, No. L-01-2146 (D. Md.) (Lit. Rel. No. 17074). The Commission charged both former officers with securities fraud in violation of Exchange Act Section 10(b) and Rule 10b-5 thereunder; with knowingly falsifying the books, records, and accounts of Alcore and ATP in violation of Exchange Act Section 13(b)(5) and Exchange Act Rule 13b2-1; and with misleading ATP's auditors in violation of Exchange Act Rule 13b2-2. The Commission also charged the former Chief Executive Officer with fraud in violation of Section 17(a) of the Securities Act based on his sales of ATP stock before the fraud at Alcore was publicly disclosed. The Commission's complaint sought injunctions, civil penalties, and officer-and-director bars against both defendants, along with disgorgement of the former Chief Executive Officer's profits from his unlawful sales of ATP stock. The same day, the United States Attorney's Office for the District of Maryland announced related criminal charges against both defendants.|
|3||ATP entered into a merger agreement with another company on September 3, 1999, and ATP's shareholders approved the merger agreement on October 21, 1999, with an expected closing of the transaction on January 31, 2000. However, the merger was ultimately aborted after the fraud at Alcore became public and ATP restated its financial results.|
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