UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 39984 / May 12, 1998 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 1034 / May 12, 1998 ADMINISTRATIVE PROCEEDING File No. 3-9603 : In the Matter of :ORDER INSTITUTING PUBLIC :PROCEEDINGS PURSUANT PEPSI-COLA PUERTO :TO SECTION 21C OF THE RICO BOTTLING COMPANY, :SECURITIES EXCHANGE ACT :OF 1934, MAKING FINDINGS :AND IMPOSING A CEASE- Respondent. :AND-DESIST ORDER : I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Pepsi-Cola Puerto Rico Bottling Company ("Pepsi P.R." or the "Respondent"). II. In anticipation of the institution of these administrative proceedings, the Respondent has submitted an Offer of Settlement (the "Offer") which the Commission has determined to accept.[1] Solely for the purpose of these proceedings and any other **FOOTNOTES** [1]:In determining to accept Pepsi P.R.'s Offer, the Commission considered the remedial acts promptly undertaken by the company and the cooperation it afforded the Commission staff. proceeding 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, the Respondent, by its Offer, consents to the entry of this order, and the findings and the imposition of the Cease-and-Desist Order set forth below. III. FACTS The Commission finds:[2] A.SUMMARY During the fiscal year ended September 30, 1996 ("fiscal 1996"), certain executives at Pepsi-Cola Puerto Rico Bottling Company ("Pepsi P.R." or the "company") engaged in a scheme to fraudulently overstate the company's financial results. These individuals intentionally falsified the financial results that the company incorporated into its Forms 10-Q for the first two quarters of fiscal 1996. This fraudulent conduct enabled the company to report a profit during the first quarter of fiscal 1996, even though Pepsi P.R. experienced a loss, and to report a smaller than actual loss during the second quarter of fiscal 1996. During fiscal 1996, the company's General Manager directed the company's Director of Finance, and others, to inflate the company's financial results by understating sales discounts and allowances and operating expenses. As a result, Pepsi P.R.'s Forms 10-Q filed with the Commission during the first two quarters of fiscal 1996 were materially false and misleading. Pepsi P.R. restated its financial results for the first two quarters of fiscal 1996 as follows: Net Income (Loss) Reported Restated Difference First Quarter $129,000 $(3,206,000) $3,335,000 Second Quarter (702,000) (6,414,000) 5,712,000 **FOOTNOTES** [2]:The findings herein are made pursuant to an Offer of Settlement submitted by Pepsi P.R. and are not binding on any other person or entity in this or any other proceeding. B.RESPONDENT 1.Pepsi-Cola Puerto Rico Bottling Company, a Delaware corporation, is a holding company that produces, distributes and markets PepsiCo beverages and other soft drink products through various divisions in Puerto Rico. On September 20, 1995, the company completed an initial public offering of seven million shares. Pepsi P.R.'s common stock is registered with the Commission pursuant to Section 12(b) of the Securities Exchange Act of 1934 and is listed for trading on the New York Stock Exchange. As of December 19, 1997, there were 21.5 million shares of the company's common stock outstanding. C. PEPSI P.R. REPORTED INACCURATE QUARTERLY RESULTS DURING THE FIRST TWO QUARTERS OF FISCAL 1996 During the first two quarters of fiscal 1996, certain executives at Pepsi P.R. intentionally reported inaccurate financial results for the company. The inaccurate results were incorporated into Pepsi P.R's financial statements included in its Forms 10-Q for the first two quarters -- the company's first two quarters after consummating its initial public offering. As a result, the company reported a profit for the first quarter of fiscal 1996, even though it actually experienced a loss, and the company reported a smaller loss than it actually experienced for the second quarter of fiscal 1996. 1.Failure to Recognize Sales Discounts and Allowances: At approximately the same time that Pepsi P.R. consummated its initial public offering in September 1995, a new bottler purchased the Coca-Cola franchise in Puerto-Rico. The new Coca-Cola bottler cut prices in an attempt to gain market share. In response, and in order to meet internal sales projections, Pepsi P.R. began offering deeper price discounts and allowances to many of its customers. These discounts and allowances should have been recorded as expenses and reduced gross sales reported. However, beginning in November 1995, Pepsi P.R.'s General Manager instructed the company's Director of Finance and others not to recognize some of these discounts and allowances. This practice of not recognizing all sales discounts and allowances continued during each month of the first and second quarters of fiscal 1996. The individuals who orchestrated and carried out this scheme knew that company's results would be incorrect if they failed to properly recognize the sales discounts and allowances that the company had granted its customers. By the end of the first and second quarters of fiscal 1996, Pepsi P.R. failed to properly recognize approximately $1.6 million and $1.8 million in sales discounts and allowances, respectively. As a result, the company materially misstated net sales and net income (loss) during each of the first two quarters of fiscal 1996. 2.Failure to Recognize Marketing Expenses: Pepsi P.R. improperly deferred recognition of approximately $1,000,000 in marketing expenses during the first quarter of fiscal 1996. In addition, the company improperly deferred recognition of marketing expenses totaling approximately $950,000 during the second quarter of fiscal 1996. Pepsi P.R.'s General Manager, Director of Finance and others were aware of these deferrals. Pepsi P.R. also understated marketing expenses related to certain marketing agreements with Pepsi-Cola International ("PCI"). Pursuant to these agreements, the company had to make certain investments in marketing, new products, packaging introductions and certain capital goods, but received reimbursements from PCI for a portion of these expenditures. By the end of the second quarter of fiscal 1996, Pepsi P.R. improperly recorded an account receivable from PCI that included approximately $1.2 million of marketing expenses which exceeded the agreed upon PCI reimbursement. PCI did not reimburse Pepsi P.R. for this $1.2 million and, therefore, Pepsi P.R. improperly overstated this receivable from PCI. As part of its restatement, Pepsi P.R. wrote off this $1.2 million during the second quarter of fiscal 1996. In addition, Pepsi P.R. improperly accounted for two other marketing related items that the company incorrectly expected PCI to cover. The first consisted of approximately $320,000 in unreimbursed expenses relating to the exploration of franchise possibilities in Italy. The second related to Pepsi P.R.'s improper treatment of approximately $500,000, related to an anticipated PCI contribution for vending machines at various schools throughout Puerto Rico. Pepsi P.R. treated PCI's anticipated contribution for all of 1996 as a reduction to expense during the second quarter, even though the company received no funds from PCI and did not order or install the vending machines during that quarter. In its restated results, the company wrote-off approximately $820,000 in the second quarter of fiscal 1996 for these items. 3.Misstatement of Accounts Payable: Due to a technical problem with the company's accounting software during fiscal 1996, the general ledger at Pepsi P.R. did not accurately reflect certain accounts payable and, therefore, did not properly reflect certain expenses. Manual entries were sometimes made to correct this problem. However, the Director of Finance instructed accountants at the company not to make manual corrections that would increase these accounts payable if the correction would result in the corresponding expenses being above budget. During the first quarter of fiscal 1996, the amount of expenses not recognized as a result of this conduct was approximately $300,000; during the second quarter it was approximately $200,000. 4.Failure to Recognize Other Expenses: Pepsi P.R. improperly failed to recognize a series of additional miscellaneous expenses during the first two quarters of fiscal 1996. These expenses included consulting fees, legal fees, entertainment expenses, temporary labor, prepaid taxes and other miscellaneous items which were improperly capitalized when they should have been booked as expenses. For the first quarter of fiscal 1996, the amount of expenses not recognized as a result of this conduct was approximately $720,000; for the second quarter it was approximately $950,000. IV. LEGAL DISCUSSION A.THE REPORTING PROVISIONS -- SECTION 13(a) OF THE EXCHANGE ACT AND RULES 13a-13 AND 12b-20 THEREUNDER Section 13(a) of the Exchange Act and Rule 13a-13 thereunder require issuers of registered securities to file with the Commission factually accurate quarterly reports. See, e.g., SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). In addition, Exchange Act Rule 12b-20 requires that periodic reports contain all information necessary to ensure that statements made in such reports are not materially misleading. No showing of scienter is necessary to establish a violation of Section 13(a). Savoy Indus., 587 F.2d at 1167. Pepsi P.R. violated Section 13(a) of the Exchange Act and Rules 13a-13 and 12b-20 thereunder by filing quarterly reports during the first and second quarters of fiscal 1996 that contained materially false and misleading financial information, including overstated net sales, understated expenses and overstated profits. B.THE RECORD-KEEPING AND INTERNAL CONTROLS PROVISIONS -- SECTIONS 13(b)(2)(A) and 13(b)(2)(B) OF THE EXCHANGE ACT Section 13(b)(2)(A) of the Exchange Act requires a reporting company to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect its transactions and disposition of assets. Section 13(b)(2)(B) of the Exchange Act, states, in pertinent part, that every "reporting company" must "devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that . . . transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles. . . ." Pepsi P.R. also violated Exchange Act Section 13(b)(2)(A) by maintaining false and misleading books, records and accounts, including false records concerning the discounts and operating expenses incurred by the company. As a result, Pepsi P.R.'s books and records during the relevant period failed to reflect fairly and accurately the company's net sales, expenses and net income. In addition, Pepsi P.R. violated Exchange Act Section 13(b)(2)(B) by failing to maintain internal accounting controls designed to ensure that it reported interim financial results which reflected the actual financial experience of the company during the relevant period. Pepsi P.R.'s Director of Finance improperly deferred discounts to conform to the instructions of the company's General Manager. The company also did not properly recognize operating expenses in ways which reflect inadequate internal accounting controls. V. FINDINGS Based on the foregoing, the Commission finds that Pepsi P.R. violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. VI. OFFERS OF SETTLEMENT The Respondent has submitted an Offer of Settlement that the Commission has determined to accept. Without admitting or denying the findings herein, Respondent consents to the Commission's issuance of this Order which makes findings, as set forth above, and orders that Pepsi P.R. cease and desist from committing any violation and any future violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. VII. ORDER Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act that Pepsi P.R. cease and desist from committing any violation and any future violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary