SECURITIES EXCHANGE ACT OF 1934
Release No. 46205 / July 15, 2002
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 1593 / July 15, 2002
ADMINISTRATIVE PROCEEDING
File No. 3-9793
In the Matter of Jean-Paul Bolduc, Brian J. Smith, C.P.A.,
Respondents. |
: |
ORDER MAKING FINDINGS AND IMPOSING A CEASE-AND-DESIST ORDER AGAINST BRIAN J. SMITH, C.P.A. |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate to accept the Offer of Settlement ("Offer") submitted by Brian J. Smith, C.P.A. ("Smith" or "Respondent") pursuant to Rule 240(a) of the Rules of Practice of the Commission, 17 C.F.R. § 201.240(a), for the purpose of settlement of this public administrative and cease-and-desist proceeding instituted by the Commission against him on December 22, 1998, pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 102(e) of the Commission's Rules of Practice.
II.
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 any of the findings contained herein, except as to the jurisdiction of the Commission over him and over the subject matter of these proceedings, which is admitted, Smith consents to the entry by the Commission of this Order.
III.
On the basis of this Order and the Respondent's Offer, the Commission finds that:1
BACKGROUND
1. Respondent Smith was an executive vice president and the chief financial officer of W.R. Grace & Co. ("Grace") from July 1989 until his resignation in July 1995.
2. Grace was a New York corporation with its principal executive offices in Boca Raton, Florida during at least 1991 through 1996. Grace's primary businesses were packaging, specialty chemicals and health care services. During the relevant time period, Grace had a December 31 fiscal year end.
3. Between at least 1991 to 1995, National Medical Care Inc. ("NMC") was Grace's main health care subsidiary, with its headquarters in Waltham, Massachusetts. NMC provided kidney dialysis and home health services and manufactured specialized medical products. During the relevant period, NMC comprised the bulk of Grace's Health Care Group, which group was, until the first quarter of 1995, one of Grace's core businesses and was reported as a segment in Grace's consolidated financial statements. The Health Care Group contributed a significant portion of the consolidated pretax earnings of Grace during the majority of the period 1991-1995.
EXCESS RESERVES AT NMC
4. As described in greater detail below, during the fiscal years 1991 through 1995 ("relevant period"), Grace engaged in fraudulent conduct by deferring income earned by NMC primarily to smooth the earnings of the Health Care Group. Grace deferred reporting income by increasing or establishing "excess reserves" that were not in conformity with generally accepted accounting principles ("GAAP"). Grace used the reserves to manipulate the reported quarterly and annual earnings of the Health Care Group and Grace.2
5. Smith, as Grace's chief financial officer, through his actions or omissions, caused this fraudulent conduct, which resulted in Grace's filing false and misleading periodic reports with the Commission, and making false and misleading statements in press releases and at analyst teleconferences. Smith, through his actions or omissions, also caused Grace to fail to make and keep books and records which accurately reflected its transactions, and to fail to maintain a system of internal accounting controls sufficient to provide assurances that transactions were recorded as necessary to permit the proper preparation of financial statements in conformity with GAAP.
Creation of the Excess Reserves
6. Beginning in 1990 or 1991, NMC experienced a significant and unanticipated increase in revenues and earnings, in excess of Grace's internal forecasts, due to changes in Medicare reimbursement procedures. During the first half of 1991, members of NMC senior management deferred some of the unanticipated income by increasing or establishing reserves (an expense), often referred to as "excess reserves." Thus, rather than report its actual earnings, NMC, at the direction of certain former members of Grace senior management, including Smith, underreported its earnings for 1991 and 1992.
7. At some point in mid-1991, as the reserves reached a level of between $10 and $20 million, certain members of NMC senior management realized that the reserves were going to be significant by year end and contacted Smith to determine how Grace wanted NMC to account for the excess reserves. Smith directed that NMC keep the excess reserves and report Health Care Group earnings consistent with Grace's targeted levels (specifically a 24% growth rate for 1991) because Grace would not be credited by the investing public for growth rates beyond the targeted levels.
8. The final reported 1991 growth rate for the Health Care Group was 24%. Grace directed NMC to report a 27-28% growth rate for the Health Care Group's net income for 1992. The final reported 1992 growth rate was 27.5%.
Use of the Excess Reserves
9. During the relevant period, the excess reserves were primarily used for profit planning purposes, i.e., to bring the Health Care Group's quarterly reported results of operations in line with Grace's targets for the Health Care Group. In general, from 1991 through the first quarter of 1995, the reported Health Care Group growth rates remained relatively steady - from about 23% to 37% -- whereas the actual growth rates fluctuated from about an 8% decline in growth to a 61% increase.
10. However, at various times, Grace also directed NMC to release some of the excess reserves to increase Grace's earnings per share. For example, Grace requested NMC to report an additional $1.5 million in income for the fourth quarter of 1994 because Grace needed the additional income for its consolidated results of operations.
11. During the relevant period, Smith also discussed the creation and use of the excess reserves with Price Waterhouse LLP ("PW"), Grace's independent auditors. (PW merged with Coopers & Lybrand L.L.P. on July 1, 1998 to form PricewaterhouseCoopers LLP.) Also during the relevant time period, PW performed audits of Grace's consolidated financial statements and issued audit reports containing unqualified opinions thereon.3
12. Smith, with the knowledge or at the direction of other members of Grace's management, directed NMC to use the excess reserves to control Grace's consolidated earnings. Smith knew or should have known that the use of the excess reserves to control Grace's consolidated earnings was improper.
FALSE AND MISLEADING FILINGS AND STATEMENTS
13. During the relevant period, Grace issued a press release and conducted an analyst teleconference at or about the same time it filed each of its Forms 10-Q and 10-K. Throughout the relevant period, the Health Care Group and Grace income amounts discussed in the teleconferences and reported in the press releases and filings included the effects of the excess reserves. Therefore, every filing, press release and teleconference was false and misleading because it included manipulated earnings amounts for the Health Care Group and Grace. Moreover, the earnings figures were materially misstated in one or more of Grace's Forms 10-K, Forms 10-Q, press releases and teleconferences.
14. Another aspect of the false and misleading nature of Grace's filings and press releases resulted from the failure to disclose the excess reserves. During the relevant period, the Management Discussion & Analysis section of Forms 10-Q and 10-K and the press releases included discussions of the results of operations for the Health Care Group and Grace. These discussions were misleading because they did not provide complete and accurate disclosure of all factors relevant to an assessment of the Health Care Group's and Grace's results of operations.
15. A third facet of the false and misleading nature of Grace's filings and press releases related to the distortion of the Health Care Group's earnings trends during the relevant period. The Health Care Group growth rates reported by Grace from 1991 through the first quarter of 1995 fluctuated less than the actual growth rates. In addition, over the 1991 through 1993 period, Grace reported steadily increasing growth in annual pretax earnings for the Health Care Group. However, the actual trend was a steady decline in the growth rate for the Health Care Group.
16. Smith knew, or should have known, that Grace's filings, press releases and analyst teleconferences during the relevant time period contained the misstatements and omissions described above. Moreover, as the chief financial officer of Grace, Smith caused, through his actions or omissions, Grace to fail to make and keep books and records which accurately reflected its transactions and to fail to maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit the preparation of financial statements in conformity with GAAP.
VIOLATIONS
17. Based upon the aforesaid conduct, Respondent Smith caused Grace's violations of Sections 10(b), 13(a), 13(b)(2) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13 and 13b2-1 thereunder.
IV.
Respondent Smith has submitted an Offer of Settlement in which, without admitting or denying the findings herein, he consents to the Commission's entry of this Order, which: V.
On the basis of the foregoing, the Commission deems it appropriate to accept Respondent's Offer.
ACCORDINGLY, IT IS ORDERED that:
By the Commission.
Jonathan G. Katz
__________________________
(1) makes findings, as set forth above; and (2) orders Smith to cease and desist from committing or causing any violation, or any future violation, of certain provisions of the federal securities laws, as set forth below. As set forth in Smith's Offer of Settlement, Smith undertakes to cooperate with the Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning any transaction that is the subject of this Order.
Secretary1 The findings herein are made pursuant to Respondent Smith's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.
2 On June 30, 1999, Grace consented to the entry of an Order by the Commission (the "Grace Order") requiring Grace to cease-and-desist from committing or causing any violation and any future violation of Sections 10(b), 13(a) and 13(b) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 thereunder. See In the Matter of W. R. Grace & Co., Securities Exchange Act Release No. 41578; Accounting and Auditing Enforcement Release No. 1140 (June 30, 1999). Pursuant to the Grace Order, Grace also undertook to establish a fund of $1 million for program(s) to further awareness and education relating to financial statements and generally accepted accounting principles.
3 On June 30, 1999, the Commission, on consent, ordered two PW partners who were involved in the audits of Grace's consolidated financial statements during the relevant period to cease-and-desist from causing any violation and any future violation of Sections 13(a) and 13(b) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. See In the Matter of Eugene Gaughan, C.P.A., Securities Exchange Act Release No. 41580; Accounting and Auditing Enforcement Release No. 1141 (June 30, 1999); In the Matter of Thomas Scanlon, C.P.A., Securities Exchange Act Release No. 41581; Accounting and Auditing Enforcement Release No. 1142 (June 30, 1999).