Securities Exchange Act of 1934
Release No. 46052 / June 10, 2002
Accounting and Auditing Enforcement
Release No. 1573 / June 10, 2002
Administrative Proceeding
File No. 3-10797
In the Matter of ASHFORD.COM, INC., KENNETH E. KURTZMAN, BRIAN E. BERGERON AND AMAZON.COM, INC. Respondent. |
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ORDER INSTITUTING PROCEEDINGS PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS AND IMPOSING A CEASE-AND-DESIST ORDER |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and they hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Ashford.com, Inc. ("Ashford.com"), Kenneth E. Kurtzman ("Kurtzman"), Brian E. Bergeron ("Bergeron") and Amazon.com, Inc. ("Amazon.com").
II.
In anticipation of the institution of these proceedings, Respondents have submitted Offers 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 in which the Commission is a party, and without admitting or denying the findings contained herein, except that Respondents admit the Commission's jurisdiction over them and over the subject matter of these proceedings, Respondents have consented 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").
III.
Facts
Based on the foregoing, the Commission finds that:
A. Respondents
Ashford.com, Inc. is a Delaware corporation based in Houston, Texas. During the relevant time, Ashford.com's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act and traded on the Nasdaq Stock Market under the ticker symbol ASFD. Ashford.com, Inc. is an online retailer of luxury goods, such as gems, jewelry and watches. On March 14, 2002, after the events described herein, Ashford.com became a wholly-owned subsidiary of another company, and terminated its registration under Section 12(g) of the Exchange Act.
Kenneth E. Kurtzman, 39, was Ashford.com's Chief Executive Officer until April 2001, when he resigned.
Brian E. Bergeron, 35, was Ashford.com's Vice President of Finance until May 2001, when he was promoted to Chief Financial Officer. Bergeron is licensed as a Certified Public Accountant by the state of Texas.
Amazon.com, Inc. is a Delaware corporation based in Seattle, Washington. Amazon.com's common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and trades on the Nasdaq Stock Market under the ticker symbol AMZN. Amazon.com is an on-line retailer.
B. Summary
This matter involves the misstatement of Ashford.com's financial results, which allowed the company to beat analysts' pro forma earnings expectations. In March 2000, Ashford.com and two of its executives improperly deferred $1.5 million in expenses under a contract with Amazon.com, causing Ashford.com to materially understate its marketing expenses. The improper deferral resulted from Ashford.com's settlement of a dispute with Amazon.com using two separate documents (prepared at Ashford.com's request), one of which Ashford.com subsequently failed to disclose to its auditors.
In September 2000, Ashford.com misstated its pro forma results by changing the classification of expenses on its income statement. For the quarters ended March 31 and June 30, 2000, Ashford.com had properly classified these expenses as marketing expenses. But in September 2000, without disclosing that it had made a change, Ashford.com classified the expenses as "depreciation and amortization," which inflated its pro forma results (which did not take depreciation and amortization into account).
Additionally, during 2000, Ashford.com misclassified a material portion of the expenses arising under a second contract with Amazon.com. Under this agreement, Ashford.com issued new Ashford.com stock to Amazon.com in exchange for advertising placements and an agreement not to compete. Ashford.com, however, classified 100% of the expenses under this contract as "depreciation and amortization," materially understating its true marketing expenses each quarter and improving its pro forma results.
C. Ashford.com's Relationship with Amazon.com
On November 29, 1999, Ashford.com entered into two contracts with Amazon.com: a New Customer Agreement and a Stock Purchase Agreement. Under the New Customer Agreement, Ashford.com agreed to pay Amazon.com $6 million to perform promotional placements and marketing services for Ashford.com targeted at Amazon.com's customer base and agreed to pay an extra $2 million if Amazon.com delivered 45,000 customers before December 31, 2000.1 Under the Stock Purchase Agreement, Amazon.com purchased 707,694 shares of Ashford.com stock for $10 million in cash and, in addition, Ashford.com issued 6.7 million shares of its stock to Amazon.com, which Ashford.com valued at $94.6 million, in return for advertising placements, as well as Amazon.com's agreement not to compete with Ashford.com in certain areas.2 After the two deals closed in December 1999, Amazon.com owned 16.6% of Ashford.com.
D. Ashford.com's Misstatement of Marketing Expenses in March 2000
1. The Valentine's Day Promotion
The first significant joint Ashford.com/Amazon.com promotion pursuant to their new relationship was for Valentine's Day 2000. Amazon.com issued coupons to its customers for substantial discounts on Ashford.com products,3 but the coupons were not assigned unique serial numbers. As a result, when an unknown coupon recipient posted the redemption instructions for certain of these coupons on a publicly accessible Internet chat board, a large number of persons who were not necessarily Amazon.com customers were able to use them. (Ashford.com and Amazon.com disputed which party was responsible for this problem.) Ashford.com considered deactivating the coupons to minimize any unintended use, but Amazon.com's management, in order to avoid creating a problem for customers, insisted that Ashford.com honor the problem coupons. With the general understanding that Amazon.com would compensate Ashford.com for the revenue lost as a result, Ashford.com agreed to honor all requests to redeem the coupons.
When the promotion ended, Ashford.com calculated that approximately 11,500 customers had redeemed the coupons, of which approximately 8,500 were unintended recipients. At the time, Ashford.com estimated that the unintended coupon use had reduced the company's revenue by about $600,000.
Beginning in late January 2000, Kurtzman contacted Amazon.com to discuss the financial assistance needed to repair the damage to Ashford.com's gross margin from the unintended coupon use. Ashford.com and Amazon.com discussed different proposals under which Amazon.com would pay $600,000 to Ashford.com and receive $600,000 in additional future revenue, but these ideas were rejected by accountants within each company, who concluded that the proposals lacked economic substance.4
By mid-March 2000, Amazon.com and Ashford.com reached a settlement, and on March 20, 2000, an Amazon.com employee signed a letter on Amazon.com letterhead, stating that Amazon.com would pay Ashford.com $600,000 and that Ashford.com would credit Amazon.com with 11,500 customers under the New Customer Agreement. This letter, however, was never sent to Ashford.com.
2. Ashford.com Asks Amazon.com to Document the Settlement Using Two Letters
After negotiating the terms reflected in the March 20 letter, Kurtzman realized that crediting Amazon.com with 11,500 customers would require Ashford.com to recognize substantial expenses associated with them during the quarter ended March 31, 2000, and that this would have a negative impact on Ashford.com's GAAP and pro forma financial results. (Ashford.com's management had previously decided to record the $6 million in cash paid to Amazon.com under the New Customer Agreement as a prepaid asset and to amortize the asset on a per-customer basis, requiring Ashford.com to recognize a marketing expense of $177.78 for each new customer referred by Amazon.com.)5
As a result, Kurtzman asked Amazon.com to change how the terms of the settlement (as set forth in the March 20 letter) were to be documented. Kurtzman suggested crediting Amazon.com with 3,000 customers during the quarter ended March 31, 2000 and to defer crediting the remaining 8,500 customers until accounting periods after March 31, 2000.6 To accomplish this deferral, Kurtzman consulted with Bergeron, who proposed that the documentation for the settlement be split into two letters. Ashford.com communicated the proposal to Amazon.com, which drafted the letters as requested. One letter, to be on Amazon.com letterhead, stated that, in settlement of the Valentine's Day promotion, Amazon.com would pay Ashford.com $600,000 in return for credit for 3,000 customers under the New Customer Agreement. The other, to be on Ashford.com letterhead, stated that Ashford.com would credit Amazon.com with 8,500 new customers as of April 1, 2000 (the first day of the following quarter). Neither letter referred to the other, and the second letter made no reference to the Valentine's Day Promotion.
Shortly thereafter, to avoid a similar problem with higher expenses in the next quarter, Kurtzman sent an e-mail to Amazon.com, asking that the 8,500 customers credited in the second letter be spread over Ashford.com's next three quarters, rather than all being credited on April 1. Amazon.com agreed to redraft the letter as requested. Bergeron reviewed the new draft letter and replied by e-mail to Amazon.com that the letter was acceptable to Ashford.com.
Communications between Amazon.com and Ashford.com employees reflect that Amazon.com employees were aware that Kurtzman did not want to "count" the full 11,500 customers for Valentine's Day because it meant Ashford.com was going to record a greater expense in Ashford.com's fourth quarter than desired. The Amazon.com employees did not know how Ashford.com was accounting for the New Customer Agreement or how large the effect would be.
3. Ashford.com and Amazon.com Exchange Letters
On March 27, 2000, Amazon.com faxed a letter on Amazon.com letterhead to Ashford.com stating that, in settlement of the Valentine's Day Promotion, Amazon.com would pay $600,000 to Ashford.com, and Ashford.com would credit Amazon.com for 3,000 customers under the New Customer Agreement. The March 27 letter did not fully reflect the settlement between Amazon.com and Ashford.com, which was that Amazon.com would pay $600,000 and receive credit for 11,500 customers.
Because the March 27 letter alone did not accurately reflect the settlement, Amazon.com transmitted the letter with a fax cover sheet making clear that the letter on Ashford.com letterhead (which gave Amazon.com credit for an additional 8,500 customers) was an integral part of the bargain. The fax cover sheet stated, in part:
If this letter is acceptable to Ashford.com, please countersign it in the space provided and fax the fully-executed copy, together with a signed copy of the other letter we discussed on Ashford.com letterhead, to me at the number above.
Please note that [Amazon.com] will not be bound by the provisions of the attached letter unless and until I receive executed copies of both letters as described above. Once I receive them, I'll have the check sent down to you via FedEx.
Kurtzman countersigned the March 27 letter and signed a letter on Ashford.com letterhead, dated March 28, that credited Amazon.com with 8,500 customers under the New Customer Agreement as follows: 3,000 as of April 1, 2000; 2,750 as of July 1, 2000; and 2,750 as of October 1, 2000. This letter made no reference to the Valentine's Day promotion or to the March 27 letter. On March 28, Amazon.com sent Ashford.com a check for $600,000, which Ashford.com recorded as revenue during the quarter ended March 31, 2000.
4. Ashford.com Misstates its Financial Results
Based upon the March 27 letter, which Ashford.com provided to its auditors, Ashford.com recognized marketing expenses of $533,340 during the quarter ended March 31, 2000. Based upon the March 28 letter, which Ashford.com failed to disclose to its auditors, Ashford.com improperly deferred the recognition of $1,511,130 in marketing expenses.
Because of Ashford.com's improper deferral of expenses, the financial statements in its Form 10-K for the year ended March 31, 2000 (its first-ever Form 10-K filing) understated the company's marketing expense for the year by 4.2%, its net loss for the year by 2.1%, and its net loss for the quarter by 3.5%. Ashford.com's reported marketing expenses were material information for investors and analysts. Among other things, analysts used this information to calculate Ashford.com's "customer acquisition cost," which was considered an important measure of the company's potential for future profitability.7
Ashford.com's understatement of its marketing expenses during the quarter ended March 31, 2000 also allowed Ashford.com to report a pro forma net loss of $0.30 per share, just beating analysts' estimates of a net loss of $0.31 per share. Without the understatement of the marketing expenses, Ashford.com would have reported a pro forma loss of $0.32, missing analysts' estimates by $0.01.
On May 2, 2000, Ashford.com issued a press release announcing that, "[e]xcluding non-cash depreciation and amortization, net loss during the quarter ended March 31, 2000 was $13.3 million, or $0.30 per share . . . ." Ashford.com's pro forma results were material information for investors and analysts. First Call, which published consensus analyst estimates for Ashford.com during the relevant time period, published only pro forma earnings estimates for the company, and Ashford.com's own earnings press releases emphasized the company's pro forma results.8
5. Ashford.com Fails to Disclose the Settlement Terms to its Auditors
In testing Ashford.com's marketing expenses for the year ended March 31, 2000, Ashford.com's auditors requested documentation from Ashford.com to support its calculation of expenses relating to the New Customer Agreement. The auditors, however, were not initially told by Ashford.com about the March 27 letter on Amazon.com letterhead. Before signing off on Ashford.com's earnings release, Ashford.com's auditors asked Kurtzman to explicitly state in a management representation letter that 3,000 new customers had been referred to the company during the Valentine's Day promotion. Kurtzman agreed to do so and signed a letter, dated May 1, 2000, stating that Ashford.com and Amazon.com had verbally agreed that Amazon.com had delivered 3,000 customers pursuant to the Valentine's Day promotion.
However, Ashford.com's auditors decided that the representation regarding the "verbal agreement" was insufficient for purposes of its audit opinion and asked Ashford.com for a document on Amazon.com letterhead, confirming the 3,000 customers, or a similar document on Ashford.com letterhead, counter-signed by Amazon.com. In response to this request, Ashford.com provided its auditors with the March 27 letter on Amazon.com letterhead, but did not provide the March 28 letter, in which the parties agreed to credit Amazon.com with 8,500 customers over the next three quarters.9
E. Ashford.com's Undisclosed Reclassification of New Customer Agreement Expenses in September 2000
During September 2000, Ashford.com changed its amortization method for the New Customer Agreement from per-customer to straight-line. Bergeron, along with Ashford.com's CFO and other personnel and advisors, participated in this decision. Although the change in amortization method was not improper, Ashford.com should have disclosed this accounting change in its filings with the Commission and failed to do so.10
More significantly, when Ashford.com changed its amortization method, it also improperly reclassified $2.9 million in New Customer Agreement expenses from marketing to depreciation and amortization ("D&A").11 Consequently, in the financial statements included in its September 30, 2000 Form 10-Q, Ashford.com materially understated its marketing costs.
The reclassification also substantially improved Ashford.com's pro forma results, which the company knew analysts followed, and lowered Ashford.com's apparent cost of customer acquisition. Analysts' estimates for the quarter ended September 30 were for pro forma losses of $0.27 per share, but Ashford.com reported pro forma losses of $0.19 per share, beating the estimates by $0.08 -- almost entirely due to the reclassification. Ashford.com's earnings announcement for the quarter, issued on October 23, made the most of these results, highlighting the company's "Far Lower Than Expected Operating Losses" and noting that the company had beaten "consensus analyst expectations by almost 30 percent." The earnings release also stated that the quarter was "the third straight quarter the company has significantly reduced losses" and that the company had shown "dramatic improvement in several key operating metrics," including customer acquisition costs, which "declined by 66 percent compared to the same quarter a year ago."
Without the reclassification, Ashford.com would have beaten analysts' estimates by a penny (3.7%), rather than by $0.08 (almost 30%). In addition, Ashford.com would have reported increased pro forma losses from the previous quarter, preventing the company from announcing three straight quarters of "significantly reduced losses" and undermining an earlier public statement by the company that it was committed to showing declining pro forma losses. While Ashford.com disclosed in its September 30 Form 10-Q that the amortized expenses for the New Customer Agreement were being recorded as "Depreciation and Amortization," Ashford.com never disclosed that it had changed the classification of these expenses.12
F. Ashford.com's Improper Classification of the Expenses Associated with the Stock Purchase Agreement
When the Stock Purchase Agreement closed in December 1999, Ashford.com valued the shares issued to Amazon.com in connection with the agreement at $94.6 million. Ashford.com recorded this amount as a prepaid expense on its balance sheet and amortized it on a straight-line basis over the life of the contract. Thus, Ashford.com recorded approximately $23.7 million per quarter as an expense.
Although the Stock Purchase Agreement expressly states that the newly-issued Ashford.com stock was granted, in part, in consideration of "advertising placements" made by Amazon.com, Ashford.com did not record any of the expenses associated with the agreement as marketing expenses. Instead, Ashford.com initially classified the entire $23.7 million as D&A on its income statement. This classification was not in conformity with GAAP, because Ashford.com should have classified the portion attributable to advertising placements as marketing expenses.13
Ashford.com's improper classification of these expenses as D&A caused it to materially understate its marketing expenses for the quarter and year ended March 31, 2000 and for the quarters ended June 30, September 30, and December 31, 2000. Because Ashford.com calculated its pro forma earnings by subtracting D&A expenses, the company significantly improved its reported pro forma results for these periods by allocating more expenses to D&A. Additionally, both the company and its analysts used the reported marketing expenses to calculate Ashford.com's "customer acquisition cost," so that, by reducing the amount allocated to marketing expenses, Ashford.com effectively lowered its apparent cost of acquiring new customers.
Ashford.com's Form 10-K for the year ended March 31, 2000, and its Form 10-Q for the quarter ended June 30, 2000, failed to disclose that Ashford.com had classified expenses under the Stock Purchase Agreement as D&A expenses.14
G. Ashford.com's Undisclosed Reclassification of Stock Purchase Agreement Expenses and "Re-reclassification" of New Customer Agreement Expenses in March 2001
In its Form 10-K for the year ended March 31, 2001, Ashford.com made another undisclosed change in its accounting policy for the two agreements with Amazon.com. Ashford.com reclassified expenses recognized under both agreements from D&A to marketing expenses.15 However, Ashford.com's March 31, 2001 Form 10-K did not disclose that the company made this reclassification.
Also in the Form 10-K, Ashford.com presented historical figures as though Ashford.com had classified the Stock Purchase Agreement expenses as marketing expenses in the previous fiscal year, when in fact Ashford.com had classified those expenses as D&A at the time. Ashford.com's Form 10-K failed to disclose that Ashford.com had reclassified the historical numbers from the previous fiscal year for marketing expenses and for D&A.16
IV.
Legal Analysis
A. Fraud Violations
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder proscribe a variety of fraudulent practices in connection with the purchase or sale of securities. Violations of Section 10(b) and Rule 10b-5 occur when an issuer makes material misstatements or omissions in periodic reports filed with the Commission, including financial statements, and trading thereafter occurs in the issuer's securities. SEC v. Texas Gulf Sulphur, 401 F.2d 833, 860-862 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969); SEC v. Great American Indus., 407 F.2d 453 (2d Cir.), cert. denied, 395 U.S. 920 (1968).
The Supreme Court, in interpreting the securities laws, has held that a fact is material if there is a "substantial likelihood that the . . . fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976); see also Basic, Inc. v. Levinson, 485 U.S. 224 (1988). Information regarding the financial condition of a company is presumptively material. SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985). Even financial misstatements that are not large in magnitude may be material if they are made intentionally to manage a company's income, hide a failure to meet analysts' expectations or sustain an earnings trend. See Ganino v.Citizens Utility Co., 228 F.3d 154, 166 (2d Cir. 2000).
Scienter is required for a violation of the antifraud provisions. Aaron v. SEC, 446 U.S. 680, 691 (1980). The Supreme Court defines scienter as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). The scienter of a company's management is imputed to the company. See, e.g., SEC v. Manor Nursing Ctrs., 458 F.2d 1082 (2d Cir. 1972). Recklessness generally satisfies the scienter requirement. Rolf v. Blyth Eastman Dillon & Co., 570 F.2d 38, 44 (2d Cir. 1978), cert. denied, 439 U.S. 1039 (1978); SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985).
As set forth above, Kurtzman, on behalf of Ashford.com, negotiated the settlement of the Valentine's Day promotion with Amazon.com. He knew that, by splitting the settlement into two letters, Ashford.com would defer recognizing marketing expenses during the quarter ended March 31, 2000 and might thereby meet analysts' earnings expectations.
As a result, Ashford.com and Kurtzman violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
B. Reporting and Books and Records Violations
Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers with securities registered under Section 12 of the Exchange Act to file annual and quarterly reports with the Commission, and the obligation to file such reports includes the requirement that they be true and correct. Rule 12b-20 further requires that such reports contain any additional information necessary to ensure that the required statements in the reports are not, under the circumstances, materially misleading. Financial statements in Commission filings that do not comply with GAAP are presumed to be misleading. Regulation S-X, 17 C.F.R. § 210.4-01(a)(1).
Section 13(b)(2)(A) of the Exchange Act requires Section 12 registrants 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)(5) of the Exchange Act provides that no person shall knowingly falsify any such book, record or account or circumvent internal controls. In addition, Rule 13b2-1 prohibits the falsification of any book, record or account subject to Section 13(b)(2)(A), and Rule 13b2-2 prohibits any director or officer of an issuer from making, or causing to be made, any false or misleading statement to an accountant, and from omitting to state material facts to an accountant, in connection with an audit of the company's financial statements or the preparation of a report required by the Commission.
No showing of scienter is required to violate Sections 13(a) and 13(b)(2)(A) and Rules 13b2-1 and 13b2-2 thereunder. See, e.g., SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979); SEC v. World-Wide Coin Invs., Ltd., 567 F. Supp. 747, 749-50 (N.D. Ga. 1983).
As discussed above, Ashford.com materially understated its marketing expenses in its Form 10-K for the year ended March 31, 2000 by improperly deferring expenses related to 8,500 customers acquired as a result of the Valentine's Day promotion. Kurtzman negotiated the "two letter" settlement with Amazon.com, which caused Ashford.com's books and records to be inaccurate. Bergeron also participated in the negotiation and approval of the "two letter" settlement. In addition, Kurtzman signed two inaccurate management representation letters that were provided to Ashford.com's auditors.
In September 2000, Ashford.com, with the participation of Bergeron, changed its classification of expenses under the New Customer Agreement from marketing expenses to D&A, but did not disclose this reclassification to its investors. This reclassification was incorrect because it did not comply with GAAP, and it was material because it substantially improved Ashford.com's reported pro forma losses, allowing the company to substantially beat analysts' earnings estimates. Ashford.com's September 2000 Form 10-Q contained material omissions, because it failed to disclose the reclassification.
Additionally, Ashford.com's initial accounting for the Stock Purchase Agreement was improper because it classified all expenses associated with the agreement as D&A, when it should have recorded a material amount of those expenses as marketing expenses. This misclassification caused Ashford.com to materially understate its marketing expenses in the financial statements for its Form 10-K for the year ended March 31, 2000 and its Forms 10-Q for the quarters ended June 30, September 30, and December 31, 2000. Ashford.com's Form 10-K for the year ended March 31, 2000 and its Form 10-Q for the quarter ended June 30, 2000 improperly failed to disclose how the company had classified expenses under the Stock Purchase Agreement.
Finally, in the financial statements included in its March 31, 2001 Form 10-K, Ashford.com failed to disclose that it had made a significant change in its accounting policy: the reclassification of all fiscal 2001 expenses under both the Stock Purchase Agreement and the New Customer Agreement as marketing expenses. This Form 10-K also failed to disclose that certain numbers presented as historical data had been reclassified.
As a result, Ashford.com violated Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. Kurtzman violated Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 thereunder and was a cause of Ashford.com's violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder. Bergeron violated Exchange Act Rule 13b2-1 and was a cause of Ashford.com's violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
C. Amazon.com's Violations
Section 21C of the Exchange Act provides that the Commission may order any person who is or was a cause of a violation of any provision of the Exchange Act, due to an act or omission the person knew or should have known would contribute to the violation, to cease and desist from causing such violations. A person may be a cause of a non-scienter based violation, such as a reporting violation, through negligent conduct that contributes to the violation. See KPMG, LLP v. SEC, 2002 U.S. App. LEXIS 9119, *25-27 (D.C. Cir. May 14, 2002). Intentional or reckless conduct is not required. See id. at *25-27.
The Amazon.com employees who negotiated and drafted the resolution of the Valentine's Day promotion on Amazon.com's behalf should have known that the purpose of splitting the settlement into two letters was to allow Ashford.com to delay the recognition of expenses. Amazon.com's acquiescence in a settlement documented with two letters facilitated Ashford.com's improper deferral of expenses.
As a result, Amazon.com was a cause of Ashford.com's violation of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder.
V.
Findings
Based on the foregoing, the Commission finds that:
A. Ashford.com, Inc. violated Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder;
B. Kenneth E. Kurtzman violated Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder and was a cause of Ashford.com's violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder;
C. Brian E. Bergeron violated Exchange Act Rule 13b2-1 and was a cause of Ashford.com's violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder; and
D. Amazon.com, Inc. was a cause of Ashford.com's violation of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder.
VI.
Order
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act that:
A. Ashford.com cease and desist from committing or causing any violation, and any future violation, of Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder;
B. Kenneth E. Kurtzman cease and desist from committing or causing any violation, and any future violation, of Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder, and from 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-1 thereunder;
C. Brian E. Bergeron cease and desist from committing or causing any violation, and any future violation, of Exchange Act Rule 13b2-1, and from causing any violation, and any future violation, of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder; and
D. Amazon.com, Inc. cease and desist from causing any violation, and any future violation, of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder.
By the Commission.
Jonathan G. Katz
Secretary
Endnotes
1 Ashford.com made a $6 million, non-refundable payment to Amazon.com up-front and agreed to make four quarterly payments of $500,000. If Amazon.com failed to meet the 45,000 new customer goal, Ashford.com would not have been required to make the last quarterly payment, and if Amazon.com failed to deliver 40,000 new customers, Amazon.com would have been required to refund the three previous quarterly payments made by Ashford.com.
2 Ashford.com executives also believed that the Stock Purchase Agreement, by creating a relationship with Amazon.com, would provide intangible benefits to Ashford.com.
3 For example, one coupon offered $75 off any purchase of more than $100.
4 At Ashford.com, Bergeron determined that one of the proposals was unacceptable, and he recommended that the company not resolve the dispute in this manner.
5 The figure of $177.78 per customer was calculated by dividing $8 million by the 45,000 customer goal.
6 Ashford.com employees thought that this structure would enable it to record expenses of $533,340 in the quarter ended March 31, 2000 and to defer $1,511,130 of expenses to later reporting periods.
7 Generally, analysts calculated the cost by dividing the quarterly marketing expenses line item by the number of new customers Ashford.com reported during the quarter.
8 Ashford.com's press releases also contained the company's GAAP results and disclosed that the pro forma results excluded depreciation and amortization expenses.
9 After providing Ashford.com's auditors with the March 27 letter, Kurtzman signed a revised management representation letter, dated June 12, 2000. This representation letter, like the earlier one, inaccurately reflected the terms of the Valentine's Day promotion settlement. Because Ashford.com had provided its auditors with the March 27 letter, however, the June 12 representation letter no longer described the agreement as verbal.
10 APB Opinion No. 20, paragraph 7 states: "A change in accounting principle results from adoption of a generally accepted accounting principle different from the one used previously for reporting purposes. The term accounting principle includes `not only accounting principles and practices but also the methods of applying them.'" Paragraph 17 of APB 20 states, "The nature of and justification for a change in accounting principle and its effect on income should be disclosed in the financial statements of the period in which the change is made. The justification for the change should explain clearly why the newly adopted accounting principle is preferable." In addition, as required by Regulation S-K, Ashford.com's September 30 Form 10-Q should have contained a letter from its independent accountants indicating whether, in their judgment, this change in accounting principle was preferable under the circumstances. Ashford.com failed to obtain and file this "preferability letter."
11 Statement of Financial Accounting Concepts No. 5 ("CON5"), paragraph 20, requires that "[c]lassification in financial statements facilitate[] analysis by grouping items with essentially similar characteristics and separating items with essentially different characteristics." The New Customer Agreement was, essentially, a marketing agreement, and expenses thereunder should therefore have been classified as marketing expenses.
12 Previous filings by Ashford.com had not disclosed how these expenses were classified.
13 See CON5 at ¶ 20 (stating that "essentially similar" items should be classified together). Moreover, companies typically classify as D&A only the depreciation and amortization of "long-lived" assets (assets amortized over a period exceeding one year). Assets that are not "long-lived," such as prepaid expenses for rent, insurance or advertising, are systematically recognized and classified on a company's income statement according to their nature: rent, insurance or advertising expenses, respectively.
14 Ashford.com's Forms 10-Q for the quarters ended September 30, 2000 and December 31, 2000 disclosed that expenses under the Stock Purchase Agreement were classified as D&A. Ashford's Form 10-K for the year ended March 31, 2001 disclosed that expenses under the Stock Purchase Agreement were classified as marketing expenses.
15 Ashford.com reclassified $71 million in expenses under the Stock Purchase Agreement and $5.5 million in expenses under the New Customer Agreement.
16 Ashford.com's earnings announcement for the year ended March 31, 2001 similarly presented reclassified "historical" numbers.