UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 37848 / October 22, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 847 / October 22, 1996 ADMINISTRATIVE PROCEEDING File No. 3-9173 ORDER INSTITUTING PUBLIC ADMINISTRATIVE PROCEEDING In the Matter of: PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT CALVIN M. DYER, OF 1934, MAKING FINDINGS, AND IMPOSING A CEASE-AND- Respondent. DESIST ORDER I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative proceeding be, and hereby is, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Calvin M. Dyer ("Dyer" or "Respondent") violated Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 thereunder and caused violations of Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20 and 13a-1 thereunder. II. In anticipation of the institution of this proceeding, Dyer has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that Respondent admits the jurisdiction of the Commission over him and over the subject matter of this proceeding, Dyer consents to the issuance of this Order Instituting Public Administrative Proceeding Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below. ==========================================START OF PAGE 2====== III. On the basis of this Order and Respondent's Offer, the Commission finds the following:1/ A. RESPONDENT Respondent Dyer was, from June 18, 1993 to July 24, 1995, Senior Vice President, Chief Financial Officer ("CFO") and Secretary of Midisoft Corporation ("Midisoft" or "the Company"). B. ENTITY INVOLVED Midisoft, founded in 1986, is a Washington State corporation with its principal place of business in Issaquah, Washington. Midisoft develops and markets interactive, audio-based software applications for the Microsoft Windows and multimedia applications market, including software that allows users to produce and manipulate music on a personal computer. The Company's common stock has been registered with the Commission pursuant to Section 12(g) of the Exchange Act since July 1993 and is quoted on The NASDAQ Stock Market. For the most recent fiscal year, ended December 31, 1995, the Company posted revenues of $5,420,000, a net loss of $12,132,000 and a net loss per share of $2.60. As of March 16, 1996, with 4,662,988 shares outstanding and a closing price per share of $3.00, Midisoft had an aggregate market value of $13,988,964. C. CONDUCT LEADING TO MIDISOFT'S MATERIALLY MISLEADING FORM 10- K FOR FISCAL 1994. Midisoft's original Form 10-K for the year ended December 31, 1994 overstated the Company's revenues by $811,000. Compared to Midisoft's restated revenues for the year of $4,898,000, this amounted to an overstatement of 16.8%. Moreover, when compared to Midisoft's restated revenues for the fourth quarter of 1994 of $685,297, Midisoft's original Form 10-K overstated the Company's revenues by 123.2%.2/ This overstatement was primarily the result of two types of conduct. First, the Company recognized revenues on goods that it did not ship to a customer prior to the end of fiscal 1994. This resulted in a revenue overstatement of $292,000. Second, the Company recognized revenue on transactions for which products were timely-shipped, but for which, at the time of shipment, 1/ The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in this or any other proceeding. 2/ Dyer signed Midisoft's 1994 Form 10-K as the Company's CFO. ==========================================START OF PAGE 3====== Midisoft had no reasonable expectation that the customer would accept and pay for the products. Midisoft accepted most of these products back as sales returns during the first three months of 1995, prior to the time the Company issued its original Form 10-K for fiscal 1994. In total, as a result of this conduct, Midisoft's original Form 10-K overstated the Company's revenues by $458,000.3/ 1. Midisoft Improperly Recognized Revenue on Goods That Did Not Ship to a Customer Prior to The End of Fiscal 1994. In December 1994, Midisoft's Sales Department obtained purchase orders from certain Midisoft customers based on the understanding that Midisoft would not deliver the products ordered unless and until it received further instructions from the customer. Nevertheless, Dyer and other Midisoft officers and employees determined that, despite the contingent nature of the orders, Midisoft would recognize revenues on these transactions during the fiscal year ending December 31, 1994. To do this, they determined, would require that Midisoft: (1) prepare the goods for shipment prior to the end of the fiscal year; and then (2) hold the goods at an off-site location until the Company received further instructions from its customers. Accordingly, Midisoft proceeded to store a total of $292,000 in goods relating to the contingent purchase orders at a freight forwarding company. Midisoft obtained phony shipping documents from the freight forwarder that made it appear that all of the goods had been shipped prior to December 31. In fact, during the first three months of 1995, Midisoft shipped only approximately $76,000 of these goods to its customers. Dyer both failed to insure that these transactions were properly reflected on Midisoft's books and records and failed to inform Midisoft's auditors of their existence. Indeed, on March 31, 1995, Dyer provided Midisoft's auditors with a Management Representation letter in which, among other things, Dyer confirmed that he knew of no: (1) material inaccuracies in Midisoft's financial statements for the year ended December 31, 1994; or (2) irregularities involving management or employees who had significant roles in the Company's system of internal accounting controls. 3/ A third cause of the overstatement was the recognition of revenues on an Original Equipment Manufacturer contract for which Midisoft had failed to fulfill its contractual obligations prior to the end of fiscal 1994. This conduct resulted in an overstatement of revenue of $61,000. ==========================================START OF PAGE 4====== 2. Midisoft Failed to Reserve Adequately for Sales Returns and, Subsequently, Misled Its Auditors Regarding Such Returns. Midisoft maintains written distribution agreements with its distributors. These agreements generally allow the distributor wide latitude to return product to Midisoft for credit whenever the product is, in the distributor's opinion, damaged, obsolete, or otherwise unsalable. Given these broad rights of return, in order to recognize revenues on sales to its distributor customers, Midisoft must be able reasonably to estimate the likelihood of future product returns and must make an allowance for such returns against its recorded revenues.4/ In connection with the preparation of Midisoft's financial statements for fiscal 1994, Dyer submitted a proposed allowance for future product returns of $105,000. This figure was unreasonably low in light of the large levels of returns Midisoft received in the first several months of 1995, which were known to Dyer prior to the end of March 1995, the time Midisoft's independent auditors finished their field work on the Company's 1994 audit. For example, in January 1995, Midisoft received from five of its largest distributors returns of $197,532; of this total, more than $163,000 was the result of one credit memo issued. In February 1995, Midisoft received additional returns from these same five distributors of $123,051. Had Dyer revised the allowance for sales returns to reflect this information, he would have had to reduce accordingly the amount of net revenue Midisoft could report for fiscal 1994. Instead, Dyer and other Midisoft officers and employees participated in a scheme to prevent Midisoft's auditors from discovering the higher levels of returns. As part of this scheme, certain Midisoft employees were instructed to prevent the Company's auditors from touring that portion of the Midisoft headquarters where the returned goods were stored. In addition, Midisoft accounting personnel altered records contained in Macola, the Company's computer accounting system, to falsely reduce the level of returns reflected in that system. In fact, in 1995 Midisoft received a total of $458,000 in returns relating to fiscal 1994 sales in excess of the $105,000 Dyer had provided for this purpose. Of this amount, Midisoft received returns of approximately $344,500 in the first quarter of 1995 alone, prior to the time the Company issued its original Form 10-K for fiscal 1994. 4/ See Financial Accounting Standards Board, Accounting Standards R75.107. ==========================================START OF PAGE 5====== D. LEGAL ANALYSIS 1. Dyer Caused Midisoft to Violate Provisions Governing Issuer Reporting, Books And Records and Internal Accounting Controls. In view of the facts set forth above, Dyer caused Midisoft to violate Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder by causing the Company to issue a materially misleading Form 10-K for the year ended December 31, 1994. This report was misleading because it overstated Midisoft's revenue for the period by 16.8%. Dyer caused the Company to violate Section 13(b)(2)(A) by: (1) preparing records that reflected the sale during fiscal 1994 of assets that were not shipped to customers during that year but were, instead, held at a freight forwarder; and (2) preparing records that reflected revenue resulting from the shipment of goods that Midisoft had no reasonable expectation its customers would accept and pay for, which goods were received as returns by Midisoft prior to the issuance of the Company's 1994 Form 10-K. Dyer also caused Midisoft to violate Section 13(b)(2)(B) by failing to maintain a system of internal accounting controls reasonably sufficient to allow the preparation of financial statements in accordance with generally accepted accounting principles and maintain accountability for the assets of the Company. 2. Dyer Is Also Liable For His Own Violations Of Certain Books and Records, Internal Accounting Controls, Representations to Auditors and Anti- Fraud Provisions. Dyer is also liable for his violations of Section 13(b)(5) and Rule 13b2-1. Dyer violated Section 13(b)(5) and Rule 13b2-1 when he knowingly or recklessly circumvented Midisoft's internal accounting controls to allow the Company to record revenues on: (1) goods that did not ship during the fourth quarter of 1994; and (2) goods that, although they were timely-shipped, were accepted back by Midisoft as returns in the first three months of fiscal 1995, prior to the time the Company filed its Form 10-K for the period. Dyer also violated Rule 13b2-2 by participating in a scheme to conceal Midisoft's improper revenue recognition from its auditors. This scheme culminated in Dyer's issuance of a Management Representation letter for Midisoft's 1994 audit in which he falsely represented that he knew of no material misstatements in Midisoft's financial reports nor of any irregularities regarding any of the personnel with significant responsibility for Midisoft's accounting functions. ==========================================START OF PAGE 6====== Lastly, Dyer signed the Company's Form 10-K for fiscal 1994 despite knowing that it materially overstated the Company's revenues for the period. Based on the foregoing, Dyer violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. IV. On the basis of this Order and the Offer submitted by Respondent, the Commission finds that Dyer: 1. committed violations of Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5, 13b2-1 and 13b2-2 thereunder; and 2. was a cause of the violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20 and 13a-1 thereunder by Midisoft. V. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Dyer cease and desist from committing or causing any violation and any future violation of Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5, 13b2-1 and 13b2-2 and from causing any violation or any future violation of Rules 13(a), 13(b)(2)(A), 13(B)(2)(B) and Rules 12b-20 and 13a-1 thereunder. By the Commission. Jonathan G. Katz Secretary