U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 17155 / September 27, 2001
Accounting and Auditing Enforcement Release No. 1460 / September 27, 2001
SEC v. Vari-L Company, Inc., David G. Sherman, Jon L. Clark, and Sarah E. Hume, Civ. Action No. 01-WM-1903 (District of Colorado)
Today, the Securities and Exchange Commission filed suit in the United States District Court for the District of Colorado against Vari-L Company, Inc. ("Vari-L") and three of its former officers for violations of the antifraud, periodic reporting, record keeping, internal controls, proxy solicitation, and lying to auditors provisions of the federal securities laws. Vari-L is a company that designs and manufactures components for wireless telecommunications products, located in Denver, Colorado. According to the Complaint, Vari-L engaged in a massive financial reporting fraud designed to show consistently increasing revenue and earnings, instead of losses, from 1996 through the quarter ended March 31, 2000 by recognizing false revenue, improperly capitalizing and depreciating costs, overstating inventory, and improperly deferring period costs.
Named as defendants in the Complaint are Vari-L, David G. Sherman of Denver, Colorado, the former president and chief executive officer, and also a director of Vari-L, Jon L. Clark of Navajo Dam, New Mexico, the former chief financial officer of Vari-L, and Sarah H. Hume of Aurora, Colorado, the former controller of Vari-L.
According to the Complaint, Sherman managed Vari-L's earnings by imposing strict revenue and earnings targets every quarter and enforcing a no-tolerance policy for failing to meet them. Hume carried out the scheme by fraudulently recognizing revenue each quarter to "make the numbers," and Clark signed filings with the Commission that he knew contained false revenue and earnings figures. The Complaint alleges that Sherman, Clark and Hume each realized the fruits of Vari-L's fraudulent financial reporting by exercising Vari-L stock options and selling Vari-L stock for substantial profits in 1999.
Specifically, the Complaint alleges Vari-L's financial statements filed with the Commission quarterly and annually from 1996 through 1999 show a company with record income each year. The Commission claims, however, that Vari-L's reported income growth was fictitious and made possible only by aggressive earnings management and outright fraud and that in reality, Vari-L had losses each fiscal year. According to the Complaint, Vari-L's March 31, 2000 balance sheet was overstated by $39 million or 132% as a result of the company overstating reported income for the quarter and in prior financial statements. The Complaint further alleges Vari-L's accounting misstatements resulted in Vari-L reporting income of $17.1 million from 1996 through the quarter ended March 31, 2000 instead of an actual $14.4 million loss for the same period.
According to the Complaint, the defendants used a range of improper practices to misstate Vari-L's financial condition. First, Vari-L allegedly improperly recognized bill and hold sales each quarter through the third quarter of 1998, such that by the quarter ended September 30, 1998, improper bill and hold sales exceeded $2 million. Second, the Commission claims Vari-L held its books open at the end of each quarter to record revenue on products that shipped after the close of the period. Third, the Complaint states Vari-L improperly capitalized costs by $24.3 million from 1996 though March 2000 by capitalizing internal labor and overhead costs as property, equipment and intangible assets. Fourth, Vari-L allegedly overstated inventory by disregarding physical inventory counts, estimating inventory amounts in lieu of physical counts, failing to value inventory based on actual costs to manufacture, and failing to provide adequate inventory reserves.
Additionally, the Complaint alleges Vari-L failed to disclose in proxy statements filed in 1998 through 2000 large amounts of compensation paid to Sherman and another officer in violation of the proxy rules, including over $200,000 paid to Sherman from 1997 through 1999 in the form of unauthorized cash advances and other undisclosed compensation.
Vari-L, without admitting or denying the allegations in the Complaint, has consented to the entry of a Final Judgment permanently restraining and enjoining it from violating the antifraud, periodic reporting, record keeping, internal controls, and proxy solicitation provisions of the federal securities laws, Sections 10(b), 13(a), 13(b)(2), and 14(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1, 14a-3, and 14a-9 thereunder. Due to a number of unique circumstances presented in this matter, the Final Judgment, when entered, will state that Vari-L's inability to obtain an unqualified audit report for its fiscal years ended June 30, 2000 and June 20, 1999, while a violation of Section 13(a) of the Exchange Act, will not be considered a violation of the injunction entered against the company. Vari-L also will be required under the Final Judgment to explain fully the reasons why it is not able to file the audited financial statements required by Section 13(a).
Additionally, without admitting or denying the allegations in the Complaint, Clark has consented to the entry of a Final Judgment permanently restraining and enjoining him from violating and/or aiding and abetting violations of the antifraud, periodic reporting, record keeping, internal controls, and lying to auditors provisions of the federal securities laws, Sections 10(b), 13(a), 13(b)(2) and 13(b)(5) of the Exchange Act and Rules 12b-20, 10b-5, 13a-1, 13a-13, 13b2-1, and 13b2-2 thereunder. Clark has also agreed to be prohibited from acting as an officer or director of a public company, to pay disgorgement, including prejudgment interest, in the amount of $166,631.87, and to pay a $50,000 civil penalty.
In separate actions today, the Commission also instituted and settled administrative proceedings against Vari-L's auditors, Charles K. Springer, Robert S. Haugen and Haugen, Springer & Co., P.C. for engaging in improper professional conduct in connection with the audits of Vari-L's financial statements and against Vari-L's former chairman, Joseph H. Kiser, for causing violations of the reporting provisions and proxy rules by Vari-L.