UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES ACT OF 1933 Release No. 7268 / February 27, 1996 SECURITIES EXCHANGE ACT OF 1934 Release No. 36893 / February 27, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 764 / February 27, 1996 ADMINISTRATIVE PROCEEDING File No. 3-8964 ______________________________ : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO SECTION 8A OF THE In the Matter of : SECURITIES ACT OF 1933, : SECTION 21C OF THE SECURITIES RICHARD A. KNIGHT, CPA, : EXCHANGE ACT OF 1934 AND RULE : 102(e) OF THE COMMISSION'S Respondent. : RULES OF PRACTICE, MAKING : FINDINGS, AND IMPOSING ______________________________: SANCTIONS I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be and they hereby are instituted against Richard A. Knight, CPA, pursuant to Section 8A of the Securities Act of 1933, Section 21C of the Securities Exchange Act of 1934 and Rule 102(e)(1) of the Commission's Rules of Practice.1/ II. In anticipation of the institution of these administrative proceedings, Knight has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of 1 The Rule provides in relevant part that "[t]he Commission may . . . deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice of and opportunity for hearing in the matter . . . (iii) to have willfully violated . . . any provision of the Federal securities laws or the rules and regulations thereunder." Rule 102(e)(1)(iii). ==========================================START OF PAGE 2====== Practice, and without admitting or denying the facts, findings, or conclusions herein, Knight consents to entry of the findings, and the imposition of the sanctions set forth below. III. FINDINGS On the basis of this Order and the Respondent's Offer of Settlement, the Commission finds the following:2/ A. Respondent and Other Relevant Entities Richard A. Knight, age 52, was an executive vice president and the chief financial officer of Chambers Development Company, Inc., from August 1990 until April 13, 1992, and a member of the company's board of directors from August 1990 until December 1992. Before joining Chambers, Knight was a managing partner with the Pittsburgh office of the accounting firm of Grant Thornton and, from 1983 through 1989, he was the audit partner on the Chambers audits. Knight is a certified public accountant licensed by the Commonwealth of Pennsylvania. Chambers Development Company, Inc. is in the business of collecting, hauling and disposing of solid waste, building and operating solid waste sanitary landfills and related operations. Its headquarters are in Pittsburgh. During the period relevant here, the company's stock was registered with the Commission pursuant to section 12(b) of the Exchange Act and traded on the American Stock Exchange.3/ Grant Thornton is a national accounting firm headquartered in Chicago, Illinois. Grant Thornton audited Chambers's financial statements for 1983 through 1991. For 1983 through 1990, the firm issued audit reports containing unqualified opinions and statements that the company's financial statements were fairly presented in conformity with generally accepted accounting principles and that the audits were conducted in accordance with generally accepted auditing standards. B. Summary This matter involves violations by Chambers, Knight and others of the antifraud provisions of the Securities Act of 1933, and the antifraud, reporting, internal controls and record- 2 The findings herein are solely for the purposes of this proceeding and are not binding on any other person or entity named as a respondent in this or any other proceeding. 3 Chambers stock ceased to be publicly traded when Chambers became a wholly-owned subsidiary of USA Waste Services, Inc., on June 30, 1995. ==========================================START OF PAGE 3====== keeping provisions of the Securities Exchange Act of 1934. From at least 1989 through March 1992, Chambers understated its expenses and overstated its earnings because it improperly capitalized certain costs. As a result, the company issued press releases and filed with the Commission registration statements and periodic reports on Forms 10-K and 10-Q that contained materially false and misleading financial statements and other financial information. Chambers violated Section 17(a) of the Securities Act and Sections 10(b), 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 10b-5, 13a-1, 13a-13 and 12b-20 thereunder. Knight violated Section 17(a) of the Securities Act, Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder, and was a cause of violations by Chambers of Sections 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.4/ C. Calculating Capitalization Chambers spent substantial sums of money on the acquisition and construction of landfills during the period from 1989 through 1991. It also spent substantial sums of money operating its landfills and other businesses. Generally accepted accounting principles allow the capitalization of incremental costs incurred in constructing a landfill up to the point in time when the landfill is ready for its intended use, provided that such costs: 1) are identifiable and segregated from ordinary operating 4 The alleged violations by Chambers are the subject of a separate, civil injunctive action. See SEC v. Chambers Development Co., Inc., Litigation Rel. No. 14496 (filed May 9, 1995) (alleging violations of Sections 10(b), 13(a) and 13(b) of the Exchange Act and Rules 10b-5, 13a-1, 13a-13, and 12b-20 thereunder, and Section 17(a) of the Securities Act of 1933). Without admitting or denying the Commission's allegations, Chambers consented to the entry of a final judgment of permanent injunction. The Commission also issued orders commencing administrative proceedings against four other Chambers officers relating to the company's capitalization practices during 1989 through March 17, 1992, and accepting their offers of settlement. In re John G. Rangos, Sr., Admin. Proc. File No. 3-8692, Exchange Act Rel. No. 34-35693, Accounting and Auditing Enforcement Rel. No. 672 (May 9, 1995); In re John J. Cushma, Admin. Proc. File No. 3-8690, Exchange Act Rel. No. 34-35691, Accounting and Auditing Enforcement Rel. No. 670 (May 9, 1995); In re William R. Nelson, Admin. Proc. File No. 3-8689, Exchange Act Rel. No. 34-35690, Accounting and Auditing Enforcement Rel. No. 669 (May 9, 1995); In re Dale O. Nolder, Jr., Admin. Proc. File No. 3- 8691, Exchange Act Rel. No. 34-35692, Accounting and Auditing Enforcement Rel. No. 671 (May 9, 1995). ==========================================START OF PAGE 4====== expenses; 2) provide a quantifiable benefit to a future period; and 3) are recoverable from future revenue.5/ Chambers capitalized material amounts of costs without complying with these principles. In the years and quarters through December 31, 1991, Chambers calculated expenses and capitalizable costs using a method that enabled it to report sustained profit margins by improperly capitalizing certain increases in its costs. Chambers determined the amounts to report as operating expenses, selling, general and administrative expenses, and depreciation and amortization expenses after the end of each quarter by multiplying revenues by a percentage for each expense category. The company's controller arrived at these percentages by starting with percentages used in prior periods and making adjustments based on internally generated reports, discussions with management about management's assessment of the company's operations and profitability during the period, and the investment community's earnings expectations. Chambers capitalized the difference between total costs incurred and expenses calculated in this manner, with the explanation that these amounts were capitalizable costs incurred to develop the company's landfills and other assets. However, Chambers did not maintain books, records and accounts that allowed capitalizable costs to be identified, quantified and segregated from ordinary expenses. Before 1991, a single Chambers employee with no formal training in accounting created detailed capitalization entries allocating the capitalized amounts from general ledger expense accounts to general ledger asset accounts after receiving the results of the controller's calculations. Typically, this employee calculated the allocations by multiplying the amount accumulated in the expense account by a percentage he derived from the preceding quarter. The employee occasionally adjusted these percentages upwards where he was aware of special projects or other considerations. In the succeeding period, he then used the increased, adjusted percentage as a starting point. It was not his practice to decrease the percentages. Chambers kept no record of the basis for the percentages used. Normally the allocations were done after the end of each quarter, following the company's earnings announcement for the period. Chambers apparently expected the detailed capitalization entries to be completed for its fourth quarter and year-end periods before announcing earnings for those periods, but sometimes these entries also were done after the announcements. 5 See, e.g., In re Touche Ross & Co., Exchange Act Rel. No. 20364, Accounting and Auditing Enforcement Rel. No. 16 (1983); S. Kay & D. Searfoss, Handbook of Accounting and Auditing 15-7 (2d ed. 1989). ==========================================START OF PAGE 5====== Occasionally the company fell behind by a quarter, so that two quarters had to be done at the same time. The quarterly amounts capitalized using these improper methods ranged from $14.7 million to $52.0 million during the period from 1989 through 1991. In each period, the amounts capitalized exceeded the company's reported earnings before taxes and extraordinary items. As a result of these practices, by the end of 1991, the company's net earnings had been misstated by an aggregate amount of $362 million. D. Knight Learned of the Company's Improper Capitalization Practices as an Auditor By at least early 1989, Knight knew of the company's improper capitalization methods from his work on auditing the company's financial statements. During the 1988 audit of Chambers's financial statements, Knight learned that Chambers had announced earnings for the fourth quarter and year end 1988 before compiling detailed capitalization entries for the period. Before signing off on the audit of the company's 1988 financial statements, Knight asked certain Chambers financial personnel, including the company's then controller and assistant controller, how they were able to prepare the company's financial statements without documentation for the amounts capitalized. In a meeting with Knight, these financial personnel explained the method of calculating capitalization described above, referring to it as the "gross margin method." They also expressed their concerns that the amounts the company was capitalizing might be excessive and that the company's methods for calculating capitalization were not reliable. Knight signed off on the 1988 audit on February 19, 1989. During 1989, the company's chief financial officer asked Knight whether the gross margin method was an accepted practice that he was comfortable with, and Knight said it was. Knight signed off on the 1989 audit on February 16, 1990. E. Knight Participated in the Company's Improper Capitalization Practices as an Officer and Director Grant Thornton's audit rotation policy required that Knight be replaced as the Chambers audit partner after the 1989 audit. During 1990, Chambers offered Knight a position as executive vice president and chief financial officer. Knight accepted the position. When Knight officially joined Chambers in August 1990, the company's financial functions were consolidated under his supervision. The company's controller, who formerly reported directly to the company's chief executive officer, began reporting to Knight. ==========================================START OF PAGE 6====== Knight participated in the preparation of the company's financial statements as the company's chief financial officer from at least the middle of 1990. Knight signed the company's Form 10-K for 1990, signed registration statements for the company's public offerings in 1991, and signed its Forms 10-Q from the second quarter of 1990 through the third quarter of 1991.6/ Knight undertook certain efforts to reform the company's capitalization practices, but they were unsuccessful. For example, a committee was formed to develop a new system for collecting information about capitalizable costs, but the system was not implemented until 1992. Chambers installed a new general ledger system in 1990, but it used different account numbers and caused confusion when the detailed capitalization entries were generated for the 1990 year end. The company's improper capitalization practices continued through 1991 and early 1992, except as follows. First, in the first quarter of 1991, the controller's calculations using the gross margin method resulted in earnings of $0.13 per share for the first quarter of 1991, less than the $0.16 per share reported for the previous quarter and less than the $0.15 per share reported for the first quarter of 1990. Knight told the controller that $0.13 per share was too low, and instructed him to prepare alternative revised calculations resulting in earnings of $0.16 and $0.17 per share. The next morning, Knight reviewed the revised calculations with the controller and approved the calculations resulting in earnings of $0.17 per share, even though the controller expressed the opinion that the revised figures were wrong. For at least two of the three remaining quarters of 1991, Knight told the controller what the company's net earnings per share should be, and the controller prepared the company's financial statements to comply with Knight's directives. Second, Knight assigned to the controller the job of creating the detailed capitalization entries. The controller objected to the assignment because he felt he lacked sufficient knowledge about the company's development activities. 6 Knight also signed the company's management representation letter to Grant Thornton in connection with the audit of the company's financial statements for the year ended December 31, 1990. In conducting the 1990 audit, Grant Thornton audited the company's capitalization figures using procedures developed and applied in prior years under Knight's direction. As in prior years, Grant Thornton issued an audit report containing an unqualified opinion that the company's 1990 financial statements were fairly presented in conformity with generally accepted accounting principles. ==========================================START OF PAGE 7====== Nevertheless, the controller attempted to do the work, starting with the percentages used in prior periods. Some of these percentages were adjusted upwards and certain costs were capitalized which the company had not capitalized before. The controller made these changes in consultation with Knight. As a result, entries were made to the company's books, records and accounts to achieve the desired financial results, rather than to reflect transactions and events in accordance with GAAP. The magnitude of the misstatements in the company's financial statements increased as a result of Knight's directives. In addition to the company's controller, other financial personnel at Chambers told Knight they disagreed with the company's 1991 capitalization figures. One of the company's regional controllers told Knight sometime during the second half of 1991 that he "thought our earnings releases were fraudulent and that we were defrauding our stockholders" because of the amounts Chambers had capitalized. There is no evidence that Knight did anything in response to this accusation. F. The 1991 Audit By the end of 1991, Grant Thornton knew from its audit work that Chambers was capitalizing a greater percentage of its costs than it had in prior years, and that it was capitalizing costs in accounts it had not capitalized before. The auditors met with the controller in early 1992 to discuss these trends. The controller explained that Chambers had capitalized expenses to the extent necessary to meet its earnings per share requirements. The auditors later met with Knight, who confirmed the controller's explanation, referring to it as a "bottoms up approach." The auditors requested additional evidential matter to support the company's capitalization figures. In the meantime, Chambers was preparing to issue financial statements showing earnings for the fourth quarter and year-end of 1991 of $0.22 per share and $0.83 per share, respectively. On January 27, 1992, Chambers gave Grant Thornton the capitalization figures underlying these financial statements. By January 30, the auditors concluded from these figures that Chambers had capitalized 100 percent of its waste segment labor costs in the fourth quarter. Chambers had actually capitalized more than 100 percent of certain other costs incurred during the quarter. The auditors knew that if Chambers followed its past practice, it would issue a press release announcing its earnings during the first week in February 1992. Knight knew that little progress had been made in resolving issues the auditors had raised involving material amounts of the company's capitalized costs. The auditors told Knight it was inappropriate for Chambers to release earnings under the circumstances. Nevertheless, Knight, in consultation with other Chambers ==========================================START OF PAGE 8====== employees, approved the company's announcement of earnings for the fourth quarter and year-end 1991 of $0.22 and $0.83 per share, respectively. Chambers made the announcement on February 5, 1992. In a series of meetings during February 1992, Knight attempted to persuade the auditors to adopt a "macro" approach to auditing capitalization, arguing that, viewing the company as a whole, the construction activity at Chambers during 1991 justified the total amount of costs capitalized. Others at Chambers became involved in the company's efforts to provide Grant Thornton with evidential matter to support the financial results announced on February 5. These efforts culminated in a meeting held on March 5, 1992, among senior management from Chambers and Grant Thornton. As a result of this meeting and the discussions that followed, it was clear to Knight that Grant Thornton would not issue an opinion on financial statements reflecting the financial results announced on February 5. Knight then began exploring the possibility of making a change in accounting method. The change under consideration would have Chambers no longer capitalizing "indirect" project costs, such as executive salaries, public relations costs, state franchise taxes, and others. This change would resolve some, but not all, of the audit issues Grant Thornton had raised. The largest audit issue left unresolved involved the company's capitalization of labor costs. Over the next ten days, Chambers began work on recalculating its earnings under the new accounting method. Knight, however, did not wait for the compilation of detailed documentation to support revised capitalization estimates. Rather, he asked one of the auditors what percentage of labor costs Chambers needed to capitalize to show a profit for 1991 even after the change in accounting method. After doing some calculations, the auditor replied it would have to be in the range of 65 to 70 percent. By March 17, 1992, acting at Knight's direction, the company's controller recalculated the company's earnings under the new accounting method based on the capitalization of 65 percent of the company's waste segment labor costs. Knight consulted the auditors before announcing Chambers's change in accounting method and revised 1991 earnings. They suggested that Chambers avoid announcing exactly what its earnings were because the audit was still in progress. Chambers rejected this suggestion on Knight's recommendation. Shortly after 4:00 p.m. on March 17, Chambers announced it was adopting the change and revising its 1991 earnings. Chambers announced its earnings per share for 1991 would be $0.48 per share, rather than $0.83 per share. After a $0.45 per share after-tax charge to reflect the cumulative effect of the change on its earnings in ==========================================START OF PAGE 9====== previous years, the company's 1991 earnings would be $0.03 per share. On March 17, documentation to support the 65 percent capitalization factor did not exist. By April 2, the controller and the auditors realized the documentation that had been developed supported capitalizing only some 46 percent of the company's labor costs. Knight attempted to make up the difference by changing the way the company computed its depletion charges. But by April 13, 1992, it was clear that this effort was futile. On April 13, 1992, Chambers announced that a preliminary analysis indicated that the earnings that would be reported in its 1991 audited financial statements would be less than $0.03 per share and that it was terminating Knight and replacing Grant Thornton as its auditor. On October 20, 1992, Chambers announced it was restating its financial results for 1989, 1990 and 1991, and changing its accounting treatment of certain capitalized costs to record them as period expenses. Chambers explained it had concluded, following consultation with its new auditor, that the amounts involved were more properly treated as expenses in the years incurred. Chambers treated the restatement as a correction of an error. The restatement adjustments reduced the company's retained earnings by $362 million, resulting in an accumulated deficit of $208 million. Among other things, Chambers disclosed that its net earnings for 1989, 1990 and 1991 were overstated as follows: ==========================================START OF PAGE 10====== Net Earnings (in millions) Amount of 1991 Original Restated Overstatement First Quarter $ 9.2 $ (14.2) $ 23.4 Second Quarter 12.2 (12.8) 25.0 Third Quarter 14.0 ( 9.3) 23.3 Fourth Quarter7/ 14.5 (35.9) 50.4 $ 49.9 $ (72.2) 122.1 1990 First Quarter $ 7.9 $ ( 6.3) $ 14.2 Second Quarter 8.8 ( 5.5) 14.3 Third Quarter 8.9 ( 9.5) 18.4 Fourth Quarter 8.7 (19.2) 27.9 $ 34.3 $ (40.5) 74.8 1989 $ 27.1 $ (16.5) 43.6 G. Legal Analysis Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit intentionally or recklessly making materially false and misleading statements in connection with the purchase or sale of a security. To establish a violation of Rule 10b-5, the Commission must show that the defendant acted with scienter, i.e., intent to deceive, manipulate or defraud, or at least recklessness. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). From at least 1989 through March 17, 1992, Knight knew or was reckless in not knowing that the company's earnings announcements and financial statements were materially false or misleading. As the company's auditor, he learned entries were made to the company's books, records and accounts to reflect profit margins determined in advance, rather than to reflect events and transactions in accordance with GAAP. When Knight joined Chambers in 1990, he had the opportunity and the authority to take action requiring Chambers to correct its false financial statements and to prepare them in accordance with GAAP. Rather than taking such action, Knight became a leading actor in the company's misconduct by directing the preparation of financial statements reflecting increasingly inflated financial results. 7 The original net earnings figures for the fourth quarter of 1991 appeared in the company's February 5, 1992, press release. Chambers revised these figures before filing its 1991 Form 10-K. ==========================================START OF PAGE 11====== Knight knew Grant Thornton had raised serious questions about the company's capitalization figures for 1991 before the company announced its earnings for the fourth quarter and year ended December 31, 1991. When Knight authorized the company's February 5, 1992, press release announcing those earnings, he knew or was reckless in not knowing that the financial information in the release was materially false. Knight knew the real reason for the change in accounting method announced on March 17, 1992, was the company's inability to resolve these questions to Grant Thornton's satisfaction. Nevertheless, he approved a press release knowing that Chambers had no reasonable basis for the financial information in it, which omitted any mention of the problems that had arisen in the audit and which misleadingly gave a different reason for the announcement. Knight willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder because he authorized the release of earnings announcements and signed filings containing financial statements which he knew or was reckless in not knowing were materially false or misleading. Section 17(a) of the Securities Act of 1933 makes it unlawful to commit fraud in the offer or sale of any securities. Chambers registered securities to be offered and sold to the public on three occasions in 1989 and on two occasions in 1991. Knight violated Section 17(a) of the Securities Act in connection with the company's public securities offerings during 1989 because he consented to the use of Grant Thornton's standard audit reports, which falsely stated that the company's financial statements were fairly presented in conformity with GAAP, in registering these securities. Knight willfully violated Section 17(a) of the Securities Act in connection with the company's public securities offerings during 1991 because the company's false or misleading financial statements, which had been included in Commission filings signed by Knight, were incorporated into the company's registration statements by reference. Knight also willfully violated Section 13(b)(5) of the Exchange Act by knowingly circumventing or knowingly failing to implement a system of internal accounting controls. In addition, he willfully violated Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder by making and causing to be made entries on the company's books, records and accounts relating to capitalization to reflect earnings per share figures determined in advance, rather than to reflect events and transactions in accordance with GAAP. In addition to these direct violations of the Securities Act and the Exchange Act, Knight also was a cause of violations by Chambers of the Exchange Act and rules and regulations thereunder. Chambers violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder by filing quarterly and annual reports that contained materially false and misleading ==========================================START OF PAGE 12====== financial information, including understated expenses and overstated earnings and assets, during the period from 1989 through 1991. E.g., SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978); SEC v. Kalvex, Inc., 425 F. Supp. 310, 316 (S.D.N.Y. 1975). Chambers violated Section 13(b)(2)(A) of the Exchange Act by failing to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflected the transactions and dispositions of its assets. As a result of its capitalization practices, Chambers maintained books, records and accounts that understated its expenses and overstated its earnings and assets, among other things. Chambers violated Section 13(b)(2)(B) of the Exchange Act by failing to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit preparation of financial statements in conformity with GAAP. Among other things, Chambers failed to develop a system of internal controls that provided reasonable assurance that costs that were properly capitalizable were identified, segregated and recorded in the company's books, records and accounts. The company's capitalization practices provided no assurance that the company's expenditures were properly recorded or that accounting irregularities would not occur. By reason of the conduct described above, Knight was a cause of the violations by Chambers of Sections 13(a) and 13(b)(2)(A) and (B) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder due to acts and omissions which he knew or should have known would contribute to such violations. IV. In view of the foregoing, the Commission has determined it is in the public interest to accept Knight's Offer of Settlement. Accordingly, IT IS HEREBY ORDERED THAT: A. Knight, pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, cease and desist from committing or causing any violation and any future violation of Section 17(a) of the Securities Act, Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) and 13(b)(5) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13 and 13b2-1 thereunder; B. Knight, pursuant to Rule 102(e) of the Commission's Rules of Practice, is permanently denied the privilege of appearing or practicing before the Commission as an accountant. ==========================================START OF PAGE 13====== By the Commission. Jonathan G. Katz Secretary