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UNITED STATES OF AMERICA SECURITIES ACT OF 1933 SECURITIES EXCHANGE ACT OF 1934 ACCOUNTING AND AUDITING ENFORCEMENT
ADMINISTRATIVE PROCEEDING
I. The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted with respect to Sunbeam Corporation ("Sunbeam" or the "Company") pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"). II. In anticipation of the institution of these administrative proceedings, Sunbeam has submitted an Offer of Settlement ("Offer") that the Commission has determined to accept. Solely for the purpose of these proceedings, and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, without admitting or denying the findings or conclusions of law as set forth below, except as to jurisdiction of the Commission over Sunbeam and over the subject matter of these proceedings, which Sunbeam admits, Sunbeam consents to the entry of this Order Instituting Public Administrative Proceedings Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, Making Findings, and Imposing a Cease-and-Desist Order ("Order") set forth below. III. The Commission makes the following findings:1 Respondent Sunbeam Corporation is a Delaware corporation headquartered in Boca Raton, Florida, that manufactures household appliances and outdoor products. At all relevant times, its common stock was registered with the Commission pursuant to Section 12(b) of the Exchange Act and traded on the New York Stock Exchange. On February 5, 2001, Sunbeam petitioned the U.S. Bankruptcy Court for the Southern District of New York for reorganization proceedings under Chapter 11 of the U.S. Bankruptcy Code. Summary From the last quarter of 1996 until June 1998, Sunbeam Corporation's senior management created the illusion of a successful restructuring of Sunbeam in order to inflate its stock price and thus improve its value as an acquisition target.2 To this end, management employed numerous improper earnings management techniques to falsify the Company's results and conceal its deteriorating financial condition. Specifically, senior management created $35 million in improper restructuring reserves and other "cookie jar" reserves3 as part of a year-end 1996 restructuring, which were reversed into income the following year. Also in 1997, Sunbeam's management engaged in guaranteed sales, improper "bill and hold" sales, and other fraudulent practices. At year-end 1997, at least $62 million of Sunbeam's reported income of $189 million came from accounting fraud. The undisclosed or inadequately disclosed acceleration of sales through "channel-stuffing" also materially distorted the Company's reported results of operations and contributed to the inaccurate picture of a successful turnaround.4 When these measures did not lead to a sale of the Company by year-end 1997, senior management took increasingly desperate measures to conceal Sunbeam's mounting financial problems, meanwhile attempting to finance the acquisition of three other companies in part through the public sale of debt securities. Management engaged in additional accelerated sales and sales for which revenue was improperly recognized, deleted certain corporate records to conceal pending returns of merchandise, and misrepresented the Company's performance and future prospects in press releases and in meetings with analysts and lenders. In June 1998, negative statements in the press about the Company's sales practices prompted Sunbeam's Board of Directors to begin an internal investigation. This resulted in the termination of certain members of senior management, including Sunbeam's chief executive officer and chief financial officer, and, eventually, in an extensive restatement of the Company's financial statements from the fourth quarter of 1996 through the first quarter of 1998.5 As a result, Sunbeam's restated 1997 income was approximately one-half of the amount previously reported. The company is presently in a reorganization proceeding under Chapter 11 of the U.S. Bankruptcy Code. FACTS Sunbeam retained new management in July of 1996 to restructure the financially ailing Company. Sunbeam's new CEO and CFO implemented an aggressive restructuring plan in an attempt to quickly improve Sunbeam's reported financial performance and thus increase its value as an acquisition target. Based on market optimism that new management could accomplish these goals, the share price of Sunbeam stock rose from $12 to a high of $52 during the period from July 1996 to March 1998. Sunbeam Created $35 Million in Improper Reserves at Year End 1996. Sunbeam took a total restructuring charge of $337.6 million at year-end 1996.6 However, management padded this charge with at least $35 million in improper restructuring and other reserves and accruals,7 excessive write-downs, and prematurely recognized expenses that materially distorted the Company's reported results of operations for fiscal year 1996, and would materially distort its reported results of operations in all quarters of fiscal year 1997, as these improper reserves were drawn into income. The most substantial contribution to Sunbeam's improper reserves came from $18.7 million in 1996 restructuring costs that management knew or was reckless in not knowing were not in conformity with Generally Accepted Accounting Principles ("GAAP").8 Sunbeam also created a $12 million litigation reserve against its potential liability for an environmental remediation. However, this reserve amount was not established in conformity with GAAP and improperly overstated Sunbeam's probable liability in that matter by at least $6 million. See Statement of Financial Accounting Standards No. 5 ("FAS 5"). In connection with its restructuring, Sunbeam planned to eliminate half of its household product lines. Its inventory of eliminated products was to be sold to liquidators at a substantial discount. In adjusting the capitalized variances9 associated with its inventory of household products at year-end 1996, however, Company management knowingly or recklessly failed to distinguish excess and obsolete inventory from "good" inventory from continuing product lines. As a result, Sunbeam understated the balance sheet value of its good household inventory at year-end 1996 by $2.1 million. This caused Sunbeam's 1996 loss to be overstated by $2.1 million, and improved Sunbeam's profitability by the same amount when household products were sold at inflated margins during the first quarter of 1997. Sunbeam had contracted to pay its advertising agency a total of approximately $2.7 million in fees and (potential) bonus to cover services rendered from late 1996 through the end of 1997. However, Sunbeam management knowingly or recklessly recognized this entire amount as a 1996 expense, including $2.3 million that related to services to be performed in 1997. (In 1996 this amount was dwarfed by the losses incurred through the Company's year-end restructuring and special charges.) This enabled Sunbeam to improperly improve its net income in all quarters of 1997, as described below. Finally, in addition to buying national advertising to create demand for its products, Sunbeam funded a portion of its retailers' costs of running local promotions. At year-end 1996, Sunbeam set its "cooperative advertising" reserve at $21.8 million without performing any test of the reasonableness of that amount. Therefore, this amount was neither probable nor arrived at by reasonable estimation, in contravention of FAS 5.10 Sunbeam's Results of Operations Were Materially Misstated for Each Quarter of 1997. Throughout 1997, Sunbeam management manipulated the Company's sales, expenses and profits to create the false appearance of quarter after quarter improvements in financial performance. To this end, management used 1996 reserves to boost Sunbeam's earnings and margins, and engaged in improper bill and hold sales and aggressive and undisclosed or inadequately disclosed accelerated sales. Improper earnings management significantly affected each of the four quarters of 1997. In the first quarter of 1997, Sunbeam inflated reported earnings and failed to make required disclosure concerning certain sources of its income. In the first quarter of 1997, Sunbeam used $4.3 million of its non-GAAP restructuring reserves to reduce current period expenses. This improved Sunbeam's income by approximately 13%. Even had these reserves been properly retained on Sunbeam's books at year-end 1996, the reduction of first quarter expenses through their release constituted a material "infrequent item," and should have been so disclosed in the Company's quarterly filing. Regulation S-K, Item 303(b); Accounting Principles Board Opinion ("APB") Nos. 28, ¶31; and 30, ¶26. It was not. As noted above, Sunbeam management improperly failed to adjust capitalized variances associated with non-impaired inventory in connection with its 1996 restructuring, which predictably boosted income in the first quarter of 1997 when the inventory was sold. In fact, this factor improved quarterly income by approximately $2.1 million (6%). Further, Sunbeam's first quarter sales included $19.6 million in deeply discounted products, which Sunbeam disposed of as part of its restructuring. This represented an infrequent event, which, absent adequate disclosure, distorted the Company's reported financial results. Regulation S-K, Item 303. Although Sunbeam had announced its intention to divest certain non-core product lines in its 1996 Form 10-K, Sunbeam made no disclosure of the effect on revenues of this one-time sales event in reporting its first quarter 1997 results. Sunbeam should have recognized first quarter advertising expenses of $330,000. However, by moving these expenses into 1996, as described above, Sunbeam understated first quarter 1997 expenses by that amount. In the first quarter of 1997, additionally, Sunbeam improperly recognized revenue on a contingent sale to a wholesaler. At the end of March 1997, just before the quarter closed, Sunbeam booked $1.5 million in revenue and $400,000 in income from a purported sale of barbecue grills to a wholesaler. The wholesaler held Sunbeam merchandise over a quarter end, without accepting any of the risks of ownership; the agreement provided that the wholesaler could return all of the merchandise if it did not sell it, and that Sunbeam would pay all costs of shipment (in both directions) and storage. Incurring no expenses in this transaction, the wholesaler in fact returned all of the grills to Sunbeam during the third quarter of 1997. GAAP does not permit the recognition of revenue on transactions lacking economic substance. See FAS 5; and Statement of Financial Accounting Concepts No. 5 ("Con. 5"), ¶83. In total, non-GAAP accounting increased Sunbeam's reported earnings for the first quarter of 1997 by $7.1 million (21.8%). Sunbeam begins a pattern of accelerating its sales. Beginning with the first quarter of 1997, moreover, Sunbeam achieved its sales goals, in large part, by offering its customers discounts and other incentives to place their purchase orders before the period when they would otherwise have done so. This practice of accelerating expected sales from later periods into the present quarter provided a misleading impression of the Company's results of operations for the present period. It also resulted in the erosion of the Company's profit margins and impoverished sales in later periods.11 Sunbeam, however, failed to disclose this practice in its quarterly filing on Form 10-Q, as required under Regulation S-K, Items 101 and 103. Sunbeam's first quarter 1997 press release was materially false and misleading. The Sunbeam press release announcing its first quarter 1997 results represented the Company's sales to be a 10% improvement over the same quarter of 1996. Sunbeam touted this purported sales growth as evidence of the success of its restructuring. In truth, without the one-time sale of eliminated product lines and the guaranteed sale of grills discussed above, sales growth would have been only 1.1% over the first quarter of 1996. With respect to earnings, the press release stated, "[t]he substantially higher earnings in the quarter from ongoing operations were due to increased sales coupled with the successful implementation of our restructuring efforts."12 The day following the earnings announcement, Sunbeam's stock price increased 5.9% over the previous day's close. There is no mention in that press release of the various forms of earnings management practiced by Sunbeam and their contribution to the first quarter results. As members of Sunbeam management knew or were reckless in not knowing, these misstatements and omissions rendered Sunbeam's press release materially false and misleading. Sunbeam overstated its second quarter income by more than 50%. In the second quarter of 1997, in order to exceed the prior quarter's improperly inflated results of operations, management again resorted to various earnings management techniques. At least $23.7 million of Sunbeam's reported second quarter income of $40.5 million did not comply with GAAP requirements. First, Sunbeam did not present fairly its results of operations because it offset, without required disclosure, $8.2 million in second quarter costs against the non-GAAP restructuring and other reserves created at year-end 1996. An additional $5.8 million of Sunbeam's second quarter net income came from the excess in the cooperative advertising reserve. Sunbeam also recognized $700,000 in revenue and $280,000 in income from another guaranteed sale.13 All of these practices, as members of Sunbeam management knew or were reckless in not knowing, were not in conformity with GAAP and hence rendered Sunbeam's second quarter 1997 financial statements false and misleading. Regulation S-X, Rule 401(a)(1); APB No. 28, ¶31. Sunbeam's improper bill and hold sales. In the second quarter of 1997, moreover, Sunbeam began using "bill and hold sales" to improve earnings. Specifically, the Company began offering its customers financial incentives to write purchase orders before they needed the goods. Thus, Sunbeam sold goods in the second quarter that it would normally have sold in later periods. Since many customers who wished to take advantage of these inducements could not burden their warehouses with out-of-season merchandise, Sunbeam offered to hold product for its customers until delivery was requested. Sunbeam typically also paid the costs of storage, shipment and insurance on the product. Moreover, the customers often retained the right, through explicit agreement or established practice, to return unsold product to Sunbeam.14 Bill and hold sales are unusual transactions subject to stringent accounting criteria. The Commission has previously articulated these criteria in In the Matter of Stewart Parness, Exchange Act Rel. No. 23507, Accounting and Auditing Enforcement Rel. ("AAER") No. 108 (August 5, 1986).15 The Parness criteria relevant to the instant case include:
Other relevant factors include: "whether [the seller] has modified its normal billing and credit terms for this buyer" and "the seller's past experiences with and pattern of bill and hold transactions." Sunbeam's bill and hold transactions did not meet the above criteria. Sunbeam procured these sales by offering price, credit and other concessions to induce customers to write purchase orders before they would otherwise have done so. Thus, it would be inaccurate to claim that the buyer had requested "the transaction be on a bill and hold basis." See In the Matter of Cypress Bioscience, Inc. et al., Exchange Act Rel. No. 37701, AAER No. 817 (Sept. 19, 1996) (bill and hold treatment improper where orders resulted from sales promotion offered by seller). It is also not the case that the buyer has "a substantial business purpose for ordering the goods on a bill and hold basis," when its only motive is to obtain the various inducements offered by the seller. Such an interpretation would substitute the seller's business purpose (e.g., to accelerate recognition of sales revenue) for the buyer's.16 Sunbeam paid the costs of insuring, storing and shipping the product, and in many instances was willing to accept the return of the product. Therefore, the customers did not accept the risks of ownership. See SEC v. Electro-Catheter Corp., et al., Lit. Rel. No. 11803, AAER No. 196 (July 15, 1988) (seller's payment for insuring and warehousing product is evidence ownership risk did not pass). In summation, these transactions were little more than projected orders disguised as sales.17 Sunbeam's improper accounting treatment for supplier rebates. Beginning during the second quarter of 1997,18 Sunbeam began recording as income rebates obtained from suppliers that properly related to later period purchases. As a result of aggressive negotiation by Sunbeam, four suppliers paid rebates in the second quarter in the total amount of $2.75 million. Under GAAP, a rebate should normally be recorded as a reduction in cost of sales in the period in which its associated sale is made. Con. 5, ¶85. That the supplier rebates obtained by Sunbeam beginning in the second quarter of 1997 were made in contemplation of future purchases, and therefore should have been recognized on a pro rata basis as the related sales were made, is confirmed by the following facts:
Sunbeam's misleading disclosure about its Second Quarter 1997 results. In its filing on Form 10-Q for the second quarter of 1997, Sunbeam reported net sales of $287.6 million, a 13.3% increase over the same quarter of the previous year. It further stated that the Company's operating margin had increased by 7.3% over the second quarter of 1996. The Company attributed these improvements to the success of its restructuring. Without the improper earnings management described above, however, Sunbeam's net sales and operating margins would have shown a substantial decline relative to the same quarter of 1996.19 Sunbeam failed to disclose material information, as described above, about the quality of its earnings and the implications of its accounting and sales practices for future results of operations. See Regulation S-K, Items 101, 303. In the third quarter of 1997, Sunbeam relied on improper accounting and further accelerated sales to achieve its earnings targets. Sunbeam reported income of $53.4 million for the third quarter of 1997. This allowed the Company to surpass analysts' estimates of 38¢ per share by 1¢. The offset of $2.9 million in current period expenses against non-GAAP restructuring reserves, the improper recognition of $705,000 in additional supplier rebates and the failure to recognize $663,000 in period advertising expenses provided approximately $4.3 million (or almost 8%) of that amount. Primarily, however, Sunbeam met its third quarter earnings targets by capturing revenue from later periods through additional discounting. Having previously initiated the process of discounting to accelerate sales, Sunbeam was forced to continue doing so or experience a major earnings shortfall. Nevertheless, Sunbeam management continued to tout the Company's income growth without disclosing the temporary expedients through which it had been achieved. In addition, management publicly denied the contention of certain analysts that Sunbeam relied on channel stuffing to achieve its revenue targets. Compounding this looming crisis of unmet expectation, management told analysts, without apparent basis in fact, that it expected sales growth of 20% for the full year and margin growth of 30% for the second half of the year. Management knew or was reckless in not knowing that the above disclosure failures were materially false and misleading. Sunbeam's earnings management reached its highest level in the last quarter of 1997. During the fourth quarter of 1997, Sunbeam management knew or recklessly disregarded facts indicating that price concessions used to accelerate sales in the third quarter were negatively affecting current period sales and profit margins. To bolster Sunbeam's reported performance for the quarter, management again used the Company's overstated restructuring and other reserves, offsetting $1.5 million of fourth quarter expenses. Sunbeam obtained an additional $1.9 million in supplier rebates in the fourth quarter that, as in previous quarters, related to future sales by Sunbeam and so should have been recorded as price discounts in the periods when the sales occurred, not as price discounts in the current period. In addition, the $12 million litigation reserve established at year-end 1996 contributed $9 million to income when the company settled for $3 million the claim to which the reserve related. At the conclusion of the fourth quarter of 1996, Sunbeam management knew or recklessly disregarded facts indicating that the $12 million reserve was at least $6 million in excess of Sunbeam's probable liability on this claim. Thus Sunbeam's fourth quarter 1997 results were knowingly or recklessly inflated by at least $6 million when that excess was released into income.20 These measures, however, did not directly address the problem of lagging sales. Therefore, management renewed its efforts to push additional product into its sales channels. After "early buy" incentives failed to generate sufficient sales, Sunbeam accelerated additional sales through a bill and hold program. Sunbeam bore all costs associated with the product until the customers requested delivery. These sales contributed $29 million in sales and $4.5 million in income to the fourth quarter's reported results. These sales, however, failed to comply with GAAP for the same reasons as Sunbeam's second quarter bill and hold sales. Indeed, that the fourth quarter bill and hold sales were not made at the request of the customer, as Parness requires, is particularly apparent in that these sales derived from a Sunbeam marketing program. See Cypress Bioscience. The Company's "distributor program" further distorted its reported results of operations. Sunbeam launched a "distributor program" in December 1997, offering discounts, favorable payment terms, guaranteed mark-ups, and (consistently) the right to return or exchange unsold product to distributors willing to accept Sunbeam product before year-end in order to generate additional purported "sales."21 These "sales" were largely without economic substance. For example, Sunbeam booked $2.9 million in revenue from a year-end transaction with one distributor to which it had previously sold goods on a consignment basis. To induce the customer to provide a conventional purchase order, Sunbeam agreed to pay for storage of the product and help the customer solicit business. The customer was also permitted to cancel the order if it could not sell the product.22 Therefore, this arrangement transferred no greater economic risk to the customer than the previous consignment arrangement. As a second example, a sale to another distributor, upon which Sunbeam booked $4.3 million in revenue, consisted of blankets custom packaged for two of Sunbeam's largest retail customers. The distributor had, in exchange for a guaranteed mark-up, in essence agreed to park this merchandise until Sunbeam's retail customer was ready to accept delivery. In total, $24.7 million in fourth quarter sales to distributors were subject to rights of return. Even if these sales were otherwise in conformity with GAAP, which many were not, they represented a significant change from Sunbeam's previous approach to marketing and distributing its product. Therefore, Sunbeam had insufficient information to set an appropriate level of reserves for returns and, consequently, could not satisfy GAAP requirements for recognizing revenue on these sales. Statement of Financial Accounting Standards No. 48, ¶8. Sunbeam improperly recognized revenue on a purported sale of parts inventory. Also in the fourth quarter of 1997, Sunbeam recorded $11 million in revenue and almost $5 million in income from a "sale" of its spare parts inventory to a fulfillment house that did not comply with GAAP requirements. Its "customer" had previously satisfied the spare parts and warranty requests of Sunbeam customers on a fee basis. The sale price had no practical relationship to any payment Sunbeam might obtain; by its terms, the contract would terminate in January 1998, absent agreement between the parties on the value of the inventory. Moreover, Sunbeam agreed to pay certain fees to its "customer" and guaranteed a 5% profit on the resale of the inventory. Sunbeam's auditors determined that the profit guarantee and indeterminate value of the contract rendered revenue recognition on this transaction improper. Sunbeam agreed to reserve $3 million against its putative profit margin on the transaction, but declined to eliminate the remaining income effect. Its auditors then passed the related proposed adjustment as immaterial.23 Sunbeam's auditors, in connection with their year end 1997 audit, proposed additional adjustments to reverse $3.5 million related to inventory overvaluation and various other accounting errors. Management deemed these items, which added 5.4% to Sunbeam's earnings for the fourth quarter, immaterial, and declined to make the proposed adjustments. Given the demonstrated sensitivity of Sunbeam's stock price to even minor earnings shortfalls, these items were not in fact immaterial. See SAB 99. Moreover, they contributed to the cumulative effect of Sunbeam's numerous accounting improprieties, which in total were material, both to the quarter and the year. Sunbeam's Year-End 1997 Disclosure Was Materially False. On January 28, 1998, Sunbeam issued a press release announcing its "record" fourth quarter and fiscal 1997 results.24 The Company claimed that its sales increase was a "clear indication that [Sunbeam's] strategy is working." It also touted its "remarkable improvement in operating margins, year over year." In fact, at least $62 million of Sunbeam's reported $189 million in income for the year did not comply with GAAP requirements.25 Significantly, 16% of Sunbeam's 1997 income came from items its auditors had determined to be improper and proposed for adjustment in either 1996 or 1997.26 Thus this press release and the associated conference call between Sunbeam management and various analysts communicated substantially overstated results of operations. This materially inaccurate financial information was also included in Sunbeam's annual report on Form 10-K, filed on March 6, 1998, contrary to the requirements of Regulation S-K, Item 303(a); and APB Nos. 28 ¶31, and 30, ¶26. Moreover, that filing contained no disclosure about the various forms of earnings management practiced by the Company and their implications for future sales and liquidity, except that it revealed (for the first time) the existence of Sunbeam's "early buy" program and that the Company had engaged in bill and hold sales. The filing suggested, however, that Sunbeam was engaged only in a limited attempt to smooth, across different selling seasons, sales from certain seasonal items, rather than (as was the case) a broad program of acceleration of revenue that would predictably lead to an earnings shortfall the following year. The filing stated, "the amount of [the] bill and hold sales at December 29, 1997 was approximately 3% of consolidated revenues." It did not disclose that bill and hold sales had been booked primarily in the final quarter, thus pulling revenue into 1997 from 1998, and had contributed approximately 10% to that quarter's sales revenue. The disclosure concerning bill and hold sales was also misleading in stating, "at the customer's request the Company may sell seasonal product on a bill and hold basis provided that ... the risk of ownership and legal title have passed to the customer." As discussed above, Sunbeam's bill and hold sales were not exclusively of seasonal product, were not made at the customer's request and did not transfer risk. In the First Quarter of 1998, Sunbeam Adopted Additional Expedients to Forestall an Earnings Shortfall. As Sunbeam entered 1998, channel stuffing though price discounting and contingent and bill and hold sales had borrowed heavily against futures sales revenue and left the Company with no options to satisfy that debt. Reports to senior management showed customers holding as much as 80 weeks of inventory of specific products. Senior management was also repeatedly informed of projected earnings shortfalls for the quarter. In brief, the Company was experiencing the results of a short-term approach to earnings management that had outlived its efficacy. Against this background, Sunbeam negotiated to purchase three other companies, Coleman, First Alert, and Signature Brands, which would allow the Company to conceal its accounting irregularities in another restructuring charge. To conclude these acquisitions, however, Sunbeam needed to raise $700 million through a Zero Coupon Bond offering and arrange a $1.7 billion revolving credit line. Indications of problems with Sunbeam's financial condition would have jeopardized these transactions. To avoid reporting a sales decline in the first quarter of 1998, Sunbeam again used bill and hold sales. The $35 million in such sales booked in the first quarter of 1998 again resulted from a program of inducing customers, already overloaded with Sunbeam inventory, to sign purchase orders well in advance of their actual need for product by offering discounts, extended payment terms and storage. Hence, they did not comply with GAAP requirements for revenue recognition. In addition, in late January, former Chief Financial Officer Russell Kersh ordered the deletion of all return authorizations from the Company's computer system.27 Although Sunbeam had little option but to accept authorized returns,28 deleting the authorization file delayed acceptance of some quantity of pending returns long enough so that they did not count against net sales for the first quarter. As a result, Sunbeam's return reserve remained inadequate. At year-end 1997, that reserve was reduced from $6.5 million to $2.5 million, without reasonable justification, improving 1997 income. As of February 8, 1998, Sunbeam had approximately $18 million in pending returns, requiring at least $4.5 million in reserves under its established approach to setting reserves. Sunbeam nevertheless reduced its sales return reserve by another $1 million at the end of February. In addition, Sunbeam changed its quarter end date from March 29 to March 31 to capture additional revenue. On March 29, Sunbeam was $29 million short of the $253.4 million in net sales it had promised to exceed in a March 19 press release. Changing Sunbeam's fiscal year to a calendar year, thereby extending the quarter by two days, permitted the Company to record another $5 million in net sales from Sunbeam's operations and almost $15 million in net sales from Coleman.29 The change in quarter-end date, although not improper in itself, led to additional disclosure failures by Sunbeam, as described below.30 The March 19 Press Release As part of its due diligence on Sunbeam's $700 million Zero Coupon debt offering, its lead underwriter learned Sunbeam might not meet analysts' expectations for the first quarter. It therefore proposed that the Company issue a press release to that effect. The following day, the Company issued a release stating:
The release inaccurately implied that Sunbeam's lower sales to retailers stemmed from a generalized effort among retailers to reduce inventory levels, rather than from Sunbeam's 1997 accelerated sales. In addition, information available to Sunbeam management did not provide any basis for projecting net sales in excess of those achieved in the first quarter of 1997. The release also made no mention of expected deterioration in earnings stemming from certain non-recurring increases in the first-quarter 1998 costs. Sunbeam's stock dropped by almost 9%, the first in what was to be a series of declines.31 The April 3 Press Release By the first week in April, Sunbeam could no longer contend that its results for the first quarter would reach the level it had predicted in its March 19 press release. On April 3, 1998, two days after the loan was funded and one day after the Signature Brands and First Alert acquisitions were completed, Sunbeam issued a release announcing that Sunbeam expected to show a loss for the quarter. It attributed the earnings shortfall to disappointing sales due to customers "continuing to manage down their inventories" and one-time charges related to the three acquisitions. On this news, Sunbeam's stock price dropped by over 24%. A statement from Sunbeam's CEO Albert J. Dunlap sought to gloss over the first quarter repercussions of its 1997 earnings management, and in particular its late December accelerated sales, as a surprising slowdown after "an excellent Holiday season." In the release and the related conference call, Sunbeam management did not disclose:
Moreover, the statement by Dunlap in the press release that Sunbeam believed "until the very end of the quarter" that it would exceed results from the first quarter of 1997 was without any reasonable basis in fact, given the alarming sales reports provided to senior management throughout the quarter. The May 11, 1998, Earnings Release and Press Conference. On May 11, 1998, Sunbeam issued its first quarter 1998 earnings release. The release disclosed a loss of 52¢ per share for the quarter, compared to earnings of 8¢ for the same quarter of the prior year.32 The release attributed the earnings shortfall, cryptically, to "lower price realization and unit volume declines." Again there was no mention of the negative effect on the first quarter of the acceleration of sales in the fourth quarter of 1997, or the positive effect of the first quarter bill and hold sales and the failure to adequately reserve for returned product. Further, the Company predicted $1 earnings per share for the year, and promised annual growth in revenues and operating margins of 10-12% and 15-18%, respectively. These predictions were without factual basis and were, in fact, contrary to internal analyses predicting earnings of approximately 60¢ per share. Also on May 11, 1998, management held a press conference in which it addressed the earnings shortfall. First, the CEO and another executive denied categorically that the Company had engaged in channel stuffing. In addition, Sunbeam's CFO reiterated the $1 per share earnings projection for the full year, and added that the Company expected to earn 5-10¢ per share in the second quarter. The quarterly number, too, was unsupportable; the prior week, internal forecasters had provided management with an earnings estimate for the second quarter of 1.9¢ per share. Sunbeam's Filing on Form 10-Q for the First Quarter of 1998. Sunbeam's Form 10-Q for the first quarter of 1998 reported net sales of $244.3 million, a decrease of $9.2 million from the comparable period in 1997. The reported net sales figure was overstated, however, because of the improper bill and hold sales and failure to reserve adequately for product returns. In the 10-Q filing, Sunbeam disclosed the existence of bill and hold sales in the first quarter but misleadingly described them as a means of accomplishing "improved customer service levels," rather than another exercise in accelerating sales to improve reported results. The Scheme Unravels. In June 1998, after an article in the financial press accused Sunbeam of accounting irregularities, its board of directors initiated an investigation. The information it obtained led it to terminate various members of management, including its chief executive officer and chief financial officer. Also in June, Sunbeam announced that its prior financial statements should not be relied upon. In November 1998, the Company issued substantially restated financial statements for the six quarters from the fourth quarter of 1996 through the first quarter of 1998. As a result of the restatement, for 1997, Sunbeam reported $93 million in income, approximately one half of the amount it had previously reported. The price of Sunbeam's stock declined from approximately $52 in early March 1998 to approximately $7 after the Company issued its restated financial statements. Sunbeam is presently in a reorganization proceeding under Chapter 11 of the U.S. Bankruptcy Code. VIOLATIONS
Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder ("the anti-fraud provisions") proscribe fraudulent practices in connection with the offer, purchase or sale of securities. An issuer and its management violate these provisions by, intentionally or with reckless disregard for the truth, making material misstatements or omissions in Commission filings. SEC v. Great American Industries, Inc., 407 F.2d 453 (2d Cir. 1968); SEC v. Geotek, 426 F. Supp. 715, 718 (N.D. Cal. 1976), affirmed, 590 F.2d 785 (9th Cir. 1979). Sunbeam violated Section 10(b) and Rule 10b-5 when it filed materially false and misleading periodic reports with the Commission and disseminated false and misleading public statements. It also violated Section 17(a) in the offer and sale of its Zero Coupon Bonds by means of the above-mentioned false and misleading filings and public statements and a materially false and misleading offering memorandum. Sunbeam's annual filing on Form 10-K for 1996 did not fairly present its results of operations and financial condition because the loss for that year was materially increased by the inclusion of non-GAAP cookie jar reserves, expenses and accruals. Further, in each of its periodic filings for 1997, its quarterly filing for the first quarter of 1998, and its Offering Memorandum for the Zero Coupon Bonds, Sunbeam intentionally did not fairly present its results from operations due to, inter alia, its practice of booking sales that did not comply with GAAP requirements, its improper release into income of non-GAAP reserves, and its failure to recognize period expenses, as described in detail above. In each of those documents Sunbeam also failed to disclose, in the MD&A section or otherwise, that it had accelerated income from later periods through channel stuffing, and the significance to the Company's future results of operations of that practice. Finally, Sunbeam's disclosure in its Form 10-Q filing for the first quarter of 1997 was misleading because the Company's income had been materially increased through an unusual item, the sale of inventory from discontinued product lines. Sunbeam's management repeated much of this misinformation in press releases and statements to Wall Street analysts.
Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers of registered securities to file with the Commission accurate annual and quarterly reports. See, e.g., SEC v. Savoy Industries, 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 Industries, 587 F.2d at 1167. Financial statements incorporated in Commission filings must comply with Regulation S-X, which in turn requires conformity with GAAP. As described in detail above, Sunbeam violated these provisions by filing annual and quarterly reports with the Commission that included materially false financial statements, and by failing to make required disclosure concerning its business practices and the significance of those practices for Sunbeam's future results of operations.
Section 13(b)(2) of the Exchange Act requires an issuer: (A) to make and keep books, records, and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of its assets, and (B) to devise and maintain a system of internal accounting controls which provide reasonable assurances that, among other things, transactions are recorded as necessary to permit preparation of financial statements in conformity with Generally Accepted Accounting Principles. As described above, Sunbeam's books and records were manifestly inaccurate on so many items and over such an extended period of time as to indicate complete failure of internal controls. As noted also, certain records were removed from the Company's computer system. Thus, Sunbeam violated Sections 13(b)(2)(A) and 13(b)(2)(B). FINDINGS Based upon the foregoing, the Commission finds that Sunbeam violated Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder. ORDER In view of the foregoing, the Commission deems it appropriate to accept the Respondent's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Sunbeam cease and desist from committing or causing any violations, and any future violations, of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, and 13a-13 thereunder. By the Commission.
Footnotes1 The findings herein are made pursuant to Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding. 2 All references to "management" or "senior management" refer to Sunbeam management at the time of the events described in this order. As noted below, on or about June 13, 1998, the Company's outside directors terminated Chief Executive Officer Albert Dunlap and shortly thereafter terminated Chief Financial Officer Russell Kersh. The Company's outside directors and its new senior management advised the public that its 1997 published financial statements should not be relied upon. The Company undertook an internal investigation, with the aid of its outside auditors and its accounting and legal advisors, and filed restated financial statements upon completion of the investigation. The Commission, in fashioning the appropriate sanction in this matter, considered Sunbeam's prompt remedial actions. 3 The term "cookie jar reserves" refers to inflated or wholly improper reserves posted to provide a cushion against earnings shortfalls in later periods, when those reserves can be drawn into income. 4 "Channel stuffing" denotes the pulling forward of revenue from future fiscal periods by inducing customers -- through price discounts, extended payment terms or other concessions -- to submit purchase orders in advance of when they would otherwise do so. Material undisclosed channel stuffing may cause a company's reported results of operations to be misleading. 5 This Order is not intended to and does not contain findings regarding the scope or accuracy of matters contained in the Company's restated financials. The staff, in its independent investigation, was not limited to those sources of information available to Company management at the time of its internal investigation. Moreover, in its restatement, Sunbeam reversed certain revenue items not addressed in this Order. 6 Unless otherwise indicated, numbers are given as approximations. "Income" refers to earnings from continuing operations before income taxes. 7 "Big bath" restructuring charges may provide a method for companies to manage earnings in later periods when excess reserves are taken into income. 8 Emerging Issues Task Force ("EITF") Issue No. 94-3 (Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)). The Company's auditors proposed an adjustment to reverse these expenses but agreed to pass on them as immaterial for the 1996 fiscal year. However, see SEC Staff Accounting Bulletin No. 99, 64 Fed. Reg. 45150, 45152 (to be codified at 17 C.F.R. pt. 211, subpt. B) (1999) on materiality of accounting errors. 9 Capitalizing variances is a method used to assign cost basis to inventory. 10 The Company's auditors issued an unqualified opinion with respect to the Company's financial statements for its 1996 fiscal year. The auditors identified, during the year-end 1996 audit, certain charges as improper. Nevertheless, they advised Sunbeam's audit committee that their proposed adjustments were not material in amount. 11 Thus, having begun the process of discounting to accelerate the recognition of sales revenue, Sunbeam was required to continue doing so or experience a major earnings shortfall. One Sunbeam officer candidly referred to this approach to earnings management as a "doom loop." 12 Sunbeam reported earnings of 24¢ per share for the quarter, surpassing the consensus estimate by 2¢. 13 Although this transaction was in an amount not in itself material, it adds to the cumulative effect of the other improper accounting practices in the second quarter. See also SEC Staff Accounting Bulletin No. 99 (1999) on the materiality of intentional errors. 14 In the second quarter of 1997, Sunbeam recognized $14 million in sales revenue and over $6 million in income from bill and hold sales, with no disclosure of this practice in its quarterly filing on Form 10-Q. 15 That opinion cautioned, however, that the specified criteria did not constitute a checklist; "[i]n some circumstances, a transaction may meet all the factors listed... but not meet the requirements for revenue recognition." Parness. 16 Obviously, the simple fact that a buyer has entered into a bill and hold transaction indicates that it found some advantage in doing so. However, the "substantial business purpose" criterion contemplated by Parness would be meaningless unless this purpose was independent of inducements created by the seller. 17 Even had Sunbeam's second quarter and later period bill and hold sales met the Parness criteria, they pulled revenue into an earlier period. A company that accelerates material amounts of sales revenue must disclose this as a business practice and discuss its financial implications for future periods. Regulation S-K, Items 101, 303. 18 Sunbeam continued this practice during later quarters. 19 The Company announced earnings for the second quarter 1997 of 30¢ per share. Sunbeam missed the consensus estimate of 31¢ per share by one penny and its stock dropped 3.5% from the previous day's close. Had the shortfall been more dramatic, it is apparent the share price would have been punished even more severely. 20 Nor did Sunbeam ever disclose the impact of the release of this litigation reserve on its financial results. 21 Previously, Sunbeam had made only limited use of distributors in marketing and distributing its products. 22 The customer, in fact, cancelled the order in April 1998. 23 The actual net pre-tax income recorded by Sunbeam as a result of this transaction was almost $5 million. First, the $7 million profit margin (the difference between the $11 million "sale" price and the $4 million carrying value of the inventory) minus the $3 million reserve, left $4 million in profit. Second, the removal of this inventory from Sunbeam's books necessitated an adjustment of inventory ledgers that added at least another $900,000 to the income statement. 24 The release stated that sales for the fourth quarter were $338 million, a 30.6 % improvement over the prior year period. The press release reported that revenue for 1997 was $1.168 billion, a 22.4% increase from 1996. The Company also announced that earnings per share from continuing operations of $1.41 were $1.51 above the loss of 10¢ reported in 1996 (excluding special charges). Nevertheless, Sunbeam missed the full-year 1997 consensus estimate by 3¢. On that news, in further confirmation of the risk inherent in missing estimates, Sunbeam's stock fell 9.5%. As detailed above, however, approximately 50% of Sunbeam's fourth quarter income did not comply with GAAP requirements. 25 This figure reflects only the issues addressed in this Order and not certain additional accounting issues addressed by the Company in its restatement. It includes income derived from overstated reserves and accruals taken at year-end 1996, conditional sales, all fourth quarter bill and hold sales, and the sham sale of spare parts. It does not include instances of "pure" channel stuffing (revenue pulled from later periods, but without GAAP failure) or conduct that caused revenue to be improperly recognized in one quarter of 1997 that would otherwise have been properly recognized in another, for example the second quarter bill and hold sales. 26 The Company's auditors issued an unqualified opinion with respect to the Company's financial statements for its 1997 fiscal year. During their 1997 year-end audit, the auditors identified certain charges as improper. The auditors nevertheless advised Sunbeam's audit committee, as they had with respect to their 1996 proposed adjustments, that the 1997 proposed adjustments were not material in amount. 27 As a consequence of the sales arrangements described above, Sunbeam customers began returning large amounts of product early in the first quarter of 1998. 28 In the summer of 1997, Sunbeam purported to adopt a policy against accepting returns of non-defective merchandise from its customers, unless approved by authorized managers. This policy was not communicated to customers and was almost certainly unenforceable, given that many of its customers had enjoyed a long-standing right of return. Moreover, as described above, Sunbeam had specifically granted rights of return to certain customers, including distributors, in the fourth quarter of 1997. 29 The acquisition was completed March 30, 1998. The Company never disclosed that its gross sales for those two days were $38 million (a substantial amount of which derived from the non-GAAP bill and hold sales described above) and that its reported $5 million net sales figure was arrived at by doubling an amount representing a daily sales average for March. 30 Sunbeam disclosed the change in the quarter-end date in an 8-K filing on April 13, 1998. It first quantified the impact of the extension in its first quarter 10-Q, filed on May 15, 1998. 31 The Zero Coupon Bond Offering Memorandum distributed to potential investors on or about March 25, 1998, contained a reprint of this press release but mirrored the results of operations disclosure contained in the Company's 1997 10-K in all other relevant respects. 32 The Company's stock price declined another 7.42% following this release. http://www.sec.gov/litigation/admin/33-7976.htm
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