SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 19578 / February 27, 2006
Accounting and Auditing Enforcement Release No. 2382 / February 27, 2006
Securities and Exchange Commission v. NetEase.com, Inc., No. 06-CV-342 (EGS) (D.D.C.)
SEC BRINGS SETTLED ACTIONS AGAINST NETEASE.COM, INC. AND TWO FORMER OFFICERS FOR IMPROPER REVENUE RECOGNITION
The Securities and Exchange Commission today filed a settled action against NetEase.com, Inc., an internet company based in China, alleging that NetEase materially overstated its revenues and understated its net loss by improperly recognizing revenue.
In its complaint, the Commission alleges that NetEase employees circumvented the company’s internal accounting controls and falsified the company’s books and records in connection with hundreds of advertising and e-commerce contracts in 2000 and 2001. According to the complaint, NetEase improperly recorded revenue from the transactions, recognizing revenue for unperformed contracts and for other agreements that lacked economic substance. The Commission also alleges that NetEase prematurely recognized revenue by artificially bifurcating advertising contracts, a technique that its employees referred to as “revenue-brought-forward.” For example, a six-month contract would be documented in two separate agreements, one with a three-month term and another “bonus contract” pursuant to which NetEase supposedly would provide free services for three additional months. According to the complaint, NetEase concealed the “bonus” contracts from its independent auditors and recognized revenue over the three-month term instead of the true six-month term.
The Commission further alleges that, as a result of these improper techniques, NetEase made false and misleading statements about its financial condition in quarterly earnings releases and in periodic reports furnished to the Commission. NetEase overstated its quarterly revenue in 2000 by amounts ranging from 5% to 290% and materially overstated its fiscal 2000 revenue by $4.3 million, or 109%. The company also understated its net loss by 16% in its “glossy” annual report for the year ended December 31, 2000, and included inflated financial results in the registration statement for its June 2000 initial public offering. In August 2001, following an internal investigation, NetEase restated its fiscal 2000 financial results and corrected, before public dissemination, its financial results for the quarter ended March 31, 2001.
Without admitting or denying the allegations in the Commission’s complaint, NetEase consented to entry of a final judgment permanently enjoining the company from violating reporting, books and records, and internal control provisions of the federal securities laws, specifically, Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Securities Exchange Act of 1934 (Exchange Act) and Rules 12b-20, 13a-16 and 13b2-1 thereunder. In accepting NetEase’s settlement offer, the Commission considered the company’s cooperation with the SEC investigation. The settlement is subject to court approval.
In related matters, the Commission also instituted settled administrative proceedings against Helen Haiwen He, NetEase’s former CFO, and Geoffrey Jie Wei, NetEase’s former Chief Accountant and Acting CFO. The Commission’s Order against Helen He found that she was NetEase’s CFO during 2000, signed false and misleading reports, and facilitated NetEase’s improper revenue recognition for two barter arrangements that lacked economic substance. The Commission’s Order against Geoffrey Wei found that Wei, in conjunction with Helen He, was responsible for NetEase’s accounting policies and preparation of its financial statements in 2000. The Commission further found that Wei was aware of or was reckless in not knowing of NetEase’s improper revenue recognition practices.
The Commission ordered Helen He to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and Rules 13b2-1 and 13b2-2 under the Exchange Act, and from causing any violations and any future violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-16 thereunder. The Commission ordered Geoffrey Wei to cease and desist from committing or causing any violations and any future violations of Rules 13b2-1 and 13b2-2 under the Exchange Act, and from causing any violations and any future violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-16 thereunder. The Commission also denied Wei, who is licensed as a CPA in China, the privilege of appearing or practicing before the Commission under Rule 102(e)(1)(iii) of the Commission’s Rules of Practice, with a right to apply for reinstatement after one year. Both Helen He and Wei consented to the Commission’s Orders without admitting or denying the findings contained in those Orders.