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UNITED STATES OF AMERICA
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| In the Matter of JOSEPH E. WILLIAMS,
Respondent. |
ORDER INSTITUTING CEASE- AND-DESIST PROCEEDINGS PURSUANT TO SECTIONS 8A OF THE SECURITIES ACT OF 1933 AND 21C OF THE SECURITIES EXCHANGE ACT OF 1934 AND FINDINGS AND ORDER OF THE COMMISSION |
I.
The Commission deems it appropriate that public administrative proceedings be, and they hereby are, instituted pursuant to Sections 8A of the Securities Act of 1933 ("Securities Act") and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Joseph E. Williams ("Respondent").
II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement ("Offer"), which 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, Respondent, without admitting or denying the matters set forth herein, consents to the issuance and entry of this Order Instituting Cease-and-Desist Proceedings Pursuant to Sections 8A of the Securities Act of 1933 and 21C of the Securities Exchange Act of 1934 and Findings and Order of the Commission ("Order").1
III.
On the basis of this Order and Respondent's Offer, the Commission finds the following:
A. Respondent
Respondent, age 45, is the former Controller of Fabri-Centers of America, Inc. ("Fabri-Centers"), now known as Jo-Ann Stores, Inc. At all relevant times, Respondent was a senior vice president and Controller of Fabri-Centers and reported to the Chief Financial Officer.
B. The Issuer
Jo-Ann Stores, Inc. ("Jo-Ann Stores"), an Ohio corporation with principal executive offices in Hudson, Ohio, is now the largest national category-dominant retailer serving the retail fabric and craft industry, operating approximately 1,050 retail stores in 49 states primarily under the names Jo-Ann Fabrics and Crafts and Jo-Ann etc.2 These stores feature a broad line of apparel, quilting and craft fabrics and sewing-related products, home decorating fabrics, floral, craft and seasonal products. Jo-Ann Stores' common stock is registered with the Commission pursuant to Section 12(b) of the Exchange Act and is listed on the New York Stock Exchange.3
C. Background
This matter stems from Fabri-Centers' application of the "gross profit method" of accounting during periods immediately before and after a $74.75 million debt offering in March 1992. Under the gross profit method, Fabri-Centers estimated its store inventory levels, gross profit and earnings by applying pre-determined margin estimates, referred to as "pegs," against reported sales. The peg estimates were based on historical operating results for each store and were accurate predictors of future profits only insofar as operating results did not change. Under the gross profit method, actual operating results for any given store could only be determined by the taking of a physical inventory and then reconciling those results against the peg estimates. Fabri-Centers' policy was to conduct store physical inventories on a cycle basis, endeavoring to inventory each store once per fiscal year. At the beginning of each month, Fabri-Centers began comparing the previous month's physical inventory counts with amounts predicted by the pegs; this reconciliation resulted in either an inventory "shrink" or "pick-up" for each store. The merchandise cost of this variance was then determined and recorded in the company's books and records for the following fiscal month. In periods between physical inventories, Fabri-Centers reported a store's financial performance based on these margin/cost estimates.
Fabri-Centers maintained a gross profit reserve account to offset the difference between the pegged inventory levels carried on its books and records and management's best estimate of actual inventory present in the company's stores. At the end of each accounting period (quarterly), Fabri-Centers typically reviewed the gross profit reserve by comparing current inventory results and margin trends against the pegged cost/margin estimates, including certain judgmental factors about the state of the Company's business.
D. Events Leading to the Debt Offering
In the fourth quarter of the fiscal year ended February 1, 1992 ("Fiscal 1992"), Fabri-Centers employed more aggressive pricing strategies than it had during the same period in the prior fiscal year. Fabri-Centers' policy was to meet or beat competitive price points and not to lose market share. In November and December, 1991 (i.e., in the fourth quarter of Fiscal 1992), during its busy holiday season, Fabri-Centers took and recorded only eight store physical inventories. Accordingly, and because the company's business was seasonal, for the fiscal year ended February 1, 1992, 72.6 percent of Fabri-Centers' sales were uninventoried.
In January 1992, Fabri-Centers resumed taking inventories on a cycle basis, and completed physical inventories at 67 of the company's 664 stores in operation at the time. On February 18, 1992, Fabri-Centers' independent auditors issued a "clean" opinion on the company's year-end financial statements without having reviewed results from the January 1992 physical store inventories. On February 19, 1992, less than three weeks after its fiscal year end, Fabri-Centers issued an earnings announcement. On February 20, 1992, the company filed with the Commission its Annual Report on Form 10-K. Both the February earnings announcement and Form 10-K reported record sales and earnings for the fiscal year and fourth quarter ended February 1, 1992. Fabri-Centers also reported a significant improvement in gross profit margins. Simultaneously, Fabri-Centers filed an S-3 registration statement for $65 million in convertible subordinated debentures with an over-allotment option of $9.75 million.
In February 1992, Respondent and other Fabri-Centers' personnel began receiving negative results from the January physical inventories. By March 2, 1992, Fabri-Centers' accounting personnel had provided Respondent and others with summaries of all 67 January inventories that identified a gross profit shortfall, or shrink, of approximately $1.1 million for just those stores. On March 4, 1992, Fabri-Centers requested that the SEC accelerate the effective date of the S-3 registration statement to March 5, 1992. The SEC granted that acceleration request, and on the same day, March 5, 1992, Fabri-Centers recorded in its general ledger results from the 67 January inventories, realizing a gross profit shortfall, or shrink, of $1,102,363.
Trends from the January inventory results were significant because of the seasonably higher fourth quarter sales and the limited number of inventories taken during that period. Had the company taken into consideration the $1.1 million shortfall shown in the January 1992 store physical inventories and extrapolated those results to all uninventoried sales, it would have been clear that the year-end gross profit reserve was materially inadequate. The failure to adjust the gross profit reserve caused the company's fourth quarter operating results and financial statements for the just-ended fiscal year to be erroneous and thus to be materially misstated.
E. Fabri-Centers' Operating Results Continue to
Worsen in First Quarter of Fiscal 1993
In February 1992, Fabri-Centers completed physical inventories at another 65 retail stores. On April 9, Fabri-Centers recorded results of the 65 February physical store inventories in its general ledger, recognizing another $1.29 million of inventory shrink. These most recent 132 January and February physical store inventories had by this time identified a $2.4 million disparity between actual inventory levels and the peg estimates carried on the company's books.
In April, 1992, Respondent participated in a meeting with other members of company management in discussing how to respond to lower-than-expected gross profit margins. As part of these discussions, Respondent and other company officers became aware of the Company's internal financial model prepared by the CFO that projected a $14 million shrink in Fiscal 1993 if the current rate of shrink continued.
Fabri-Centers took physical inventories at another 76 stores in March 1992. Results of these inventories were summarized on a rolling basis throughout April 1992. On May 7, 1992, Fabri-Centers recorded results of the 76 March physical store inventories in its general ledger, recognizing another $1.66 million of inventory shrink. By May 7, 1992, the company had identified a variance between actual inventory levels and the peg estimates carried on the company's books of over $4 million for the 208 stores inventoried in January, February and March 1992.
Fabri-Centers' first quarter of Fiscal 1993 ended on May 2, 1992. On or about May 12, 1992, the CFO and Respondent directed Fabri-Centers' merchandise accounting department to record a $2.0 million reduction to the company's gross profit reserve. This reduction, coming at a time when the shrink information indicated that the company should have estimated a higher gross profit reserve to account for the difference between pegged estimates and anticipated results, caused the company to overstate gross profit, inventory levels and earnings in its books and records for the first quarter of fiscal 1993.
On Saturday, May 16, 1992, Fabri-Centers' CFO prepared a hand-written memo addressed to the company's Executive Committee, with a copy to Respondent (who was not a member of the Executive Committee). The memo stated that: (1) inventory variances were averaging $20,000 per store, and (2) the company should have seen the percentage shortfall at Fiscal 1992 year-end.
F. Fabri-Centers' Materially False
and Misleading First Quarter Form 10-Q
On June 16, 1992, Fabri-Centers filed with the Commission its Form 10-Q for the first quarter of Fiscal 1993. Due to the company's continuing failure to record appropriate amounts in the gross profit reserve, the financial statements contained in the first quarter Form 10-Q materially misstated inventory levels, gross profit and pre-tax earnings. Respondent reviewed and approved the financial statements contained in the company's first quarter Form 10-Q.
IV.
OPINION
A. Applicable Law
Section 17(a)(2) of the Securities Act prohibits an issuer from obtaining money by means of an untrue statement or material omission in connection with the offer or sale of securities. Section 17(a)(3) prohibits any transaction, practice or course of business which would operate as a fraud or deceit upon actual or potential purchasers. Violations of Sections 17(a)(2) and (3) do not require proof of scienter and can be proven by negligent conduct. Aaron v. SEC, 446 U.S. 680, 694 (1980).
Section 13(a) of the Exchange Act requires that issuers with securities registered pursuant to Section 12 of the Exchange Act file periodic and other reports with the Commission containing such information as the Commission prescribes by rule. Rule 13a-1 requires issuers to file annual reports and Rule 13a-13 requires issuers to file quarterly reports. Implicit within the reporting requirements of Section 13(a), Rules 13a-1 and 13a-13 is an obligation that the information reported be true and correct. See, e.g., SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Additionally, Rule 12b-20 requires issuers to include such further material information necessary to make these periodic reports not misleading under the circumstances they were made.
Rule 13b2-1 under the Exchange Act prohibits the direct or indirect falsification, or causing to be falsified, of any book, record or account that issuers are required to maintain pursuant to the Exchange Act.
Evidence of negligence is sufficient to establish that a person caused a violation of Section 13(a), Rule 13a-1, Rule 13a-13 and Rule 12b-20 or violated Rule 13b2-1.
B. Violations by Respondent
Respondent violated Sections 17(a)(2) and (3) of the Securities Act, and caused violations of Section 13(a) of the Exchange Act and Exchange Act Rules 13a-1 and 12b-20 in connection with the Form 10-K and the S-3 Registration Statement. Respondent violated Rule 13b2-1 of the Exchange Act by permitting the company's gross profit reserve and earnings to be recorded without properly increasing the gross profit reserve in the first quarter of Fiscal 1993. Respondent caused the company to violate Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder when he reviewed and approved the financial statements for the company's Form 10-K for Fiscal 1992 and for the Form 10-Q for the first quarter of Fiscal 1993.
V.
FINDINGS
The Commission finds that Respondent violated Sections 17(a)(2) and (3) of the Securities Act and Exchange Act Rule 13b2-1 and caused violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
VI.
OFFER OF SETTLEMENT
Respondent has submitted an Offer in this proceeding which the Commission has determined to accept. Respondent, in his Offer, consents to this Order making findings, as set forth above, and ordering Respondent to cease and desist from committing or causing any violation of, and committing or causing any future violation of, Sections 17(a)(2) and (3) of the Securities Act, Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13 and 13b2-1 thereunder.
VII.
ORDER
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Respondent cease and desist from committing or causing any violation of, and committing or causing any future violation of, Sections 17(a)(2) and (3) of the Securities Act, Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13 and 13b2-1 thereunder.
By the Commission.
Jonathan G. Katz
Secretary
1 Respondent also consented to the entry of an order requiring him to pay a $25,000 civil penalty, $23,640.00 in disgorgement and $20,976.33 in prejudgment interest thereon. SEC v. Fabri-Centers of America, Inc. Robert L. Norton and Joseph E. Williams, Case No. 5:97CV1216 (N.D. Ohio)
2 At fiscal year-end 1992, Fabri-Centers operated 664 retail stores primarily under the names Jo Ann Fabrics and New York Fabrics and Crafts.
3 On February 18, 1997, the Commission filed a complaint in the United States District Court for the District of Columbia against Fabri-Centers, the Respondent, and Fabri-Centers' former Chief Financial Officer alleging violations of Section 17(a) of the Securities Act and Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-13, 13b2-1 and 13b2-2 thereunder. Fabri-Centers consented, without admitting or denying the allegations of the complaint, to the entry of a final judgment of permanent injunction and an order that the company disgorge $3.28 million. See SEC v. Fabri-Centers of America, Inc., et. al., Civ. Act. No. 1:97CV00319. (February 18, 1997) The action was subsequently transferred to the United States District Court for the Northern District of Ohio, Case No. 5:97CV1216. Also on February 18, 1997, Fabri-Centers' CEO and President consented, without admitting or denying the allegations, to the entry of a cease-and-desist order finding that he violated or caused violations of Sections 17(a)(2) and (3) of the Securities Act and Section 13(a) of the Exchange Act and Exchange Act Rules 12b-20, 13a-13 and 13b2-2. In the Matter of Alan D. Rosskamm, Admin. Proc. No. 3-9248 (February 18, 1997). Concurrently with the issuance of this Order, Fabri-Centers' former Chief Financial Officer consented, without admitting or denying the allegations, to the entry of a separate cease-and-desist order finding that he violated Sections 17(a)(2) and (3) of the Securities Act and Exchange Act Rules 13b2-1 and 13b2-2 and that he caused the company to violate Section 13(a) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1 and 13a-13. In the Matter of Robert L. Norton, Admin. Proc. No. 3-10143 (February 7, 2000). Norton also consented to entry of a court order requiring him to pay a $50,000 civil penalty, $46,916.68 in disgorgement and $41,630.29 in prejudgment interest thereon. SEC v. Fabri-Centers of America, Inc. Robert L. Norton and Joseph E. Williams, Case No. 5:97CV1216 (N.D. Ohio)
http://www.sec.gov/litigation/admin/34-42412.htm
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