Endocare, Inc., Kevin M. Quilty, and Jerry W. Anderson
U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19772 / July 25, 2006
Accounting and Auditing Enforcement Release No. 2464 / July 25, 2006
Securities and Exchange Commission v. Endocare, Inc., Kevin M. Quilty, and Jerry W. Anderson, Civil Action No. CV 06-4502 RSWL (SSx)(C.D.Cal.).
SEC Charges Endocare With Accounting Fraud and Misleading Statements About Internal Investigation
Endocare Agrees to Pay $750,000 Penalty; Three Senior Officials Also Agree to Settlements
The Securities and Exchange Commission (Commission) announced on July 19, 2006 that Irvine, California-based Endocare, Inc. agreed to settle fraud charges for engaging in a widespread accounting fraud and then making false and misleading public statements about the results of an internal investigation. At the time, Endocare developed and distributed medical devices for use in the treatment of various types of cancers and urological ailments.
To settle the Commission's charges, which were filed in United States District Court for the Central District of California, Endocare agreed to pay a $750,000 civil penalty and to be permanently enjoined from the antifraud, reporting, recordkeeping, and internal controls provisions of the federal securities laws. Endocare agreed to settle the Commission's action without admitting or denying the allegations.
The Commission also announced that Endocare's senior vice president of sales, Kevin Quilty (Quilty), age 52, of Washington Crossing, Pennsylvania, and the former president of an Endocare subsidiary, Jerry W. Anderson (Anderson), age 59, of Gunter, Texas, agreed to settle Commission charges for recordkeeping and internal controls violations and (in the case of Quilty) for aiding and abetting Endocare's reporting violations. Quilty agreed to a permanent injunction and to pay $23,749 in disgorgement and interest, and a $25,000 penalty. Anderson agreed to a permanent injunction and to pay a $35,000 penalty. In a separate administrative proceeding instituted by the Commission on July 19, Endocare's former director of sales for the Southeast region, L. Michael Hart, age 58, of Fort Pierce, Florida, agreed to cease and desist from causing Endocare's reporting and recordkeeping violations. All agreed to settle the charges without admitting or denying the allegations and findings. The settlements are subject to approval by the court.
According to the Commission's complaint, Endocare engaged in improper revenue recognition practices, ranging from false sales to undisclosed side agreements, and improperly understated or deferred expenses to inflate earnings. As alleged in the complaint, Endocare reported a consistent history of "record revenue" growth quarter over quarter, reporting $2.8 million for the first quarter of 2001 to $11.4 million for the second quarter of 2002. The complaint alleges that, as a result of its fraudulent accounting, Endocare overstated revenue by at least 33% for the second quarter of 2002. The complaint further alleges that Endocare understated its pre-tax loss for 2001 by 20% and falsely reported pre-tax earnings for the first two quarters of 2002, rather than its actual substantial losses.
The complaint further alleges that Quilty and Anderson assisted in Endocare's improper revenue practices. The complaint alleges that Quilty entered into numerous undisclosed side agreements containing contingent terms and parked product shipped to Endocare-controlled warehouses. The complaint also alleges that Anderson created fictitious customers used to purchase $1.2 million in product in September 2002.
Also according to the complaint, Endocare committed additional securities law violations in the course of investigating allegations of improper accounting raised by its acting controller. In late October 2002, after receiving the controller's allegations, Endocare's audit committee retained a law firm to perform an investigation. Endocare's auditors at the time, KPMG, suggested that the audit committee hire independent counsel and an independent forensic accountant to conduct the investigation. In November 2002, after reviewing the work of a forensic accountant that the audit committee had retained, KPMG informed the audit committee that it was not prepared to complete its quarterly review until an expanded internal investigation had been performed. In December 2002, KPMG informed the audit committee that it had concluded that it could no longer rely on the representations of Endocare's management, and that it was withdrawing its report on Endocare's financial statements for the last fiscal year. Following these events, however, in March 2003 Endocare issued a press release in which it announced that, after an "independent review and investigation," the audit committee and its advisors had concluded that there was "no indication of fraud or intentional wrongdoing by management." The complaint alleges that this press release was false and misleading because, first, Endocare in fact had not conducted an independent investigation, and second, its internal review had in fact revealed substantial evidence of fraud or intentional wrongdoing.
In its complaint, the Commission charged Endocare with violating the antifraud provisions, Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 thereunder of the Securities Exchange Act of 1934 (Exchange Act); the reporting provisions, Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder; recordkeeping provision, Section 13(b)(2)(A) of the Exchange Act; and internal controls provision, Section 13(b)(2)(B) of the Exchange Act. The Commission further charged Quilty and Anderson with aiding and abetting and violating the recordkeeping provisions, Sections 13(b)(2)(A) and 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder, and additionally as to Quilty, aiding and abetting Endocare's violations of reporting provisions, Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
The settled administrative proceeding against Hart finds that he executed side agreements containing contingent terms, in violation of above-described reporting and recordkeeping provisions of the federal securities laws.
The Commission's investigation is continuing.
