UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 37889 / October 29, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 850 / October 29, 1996 ADMINISTRATIVE PROCEEDINGS File No. 3-9176 In the Matter of: INTERNATIONAL ENERGY DEVELOPMENT CORPORATION and JEROME B. RICHTER, Respondents. ORDER INSTITUTING PROCEEDINGS PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS, AND IMPOSING A CEASE-AND-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 International Energy Development Corporation ("IEDC" or the "Company") violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder; and whether Jerome B. Richter ("Richter") violated Rule 13b2-2 of the Exchange Act and caused violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. II. In anticipation of the institution of this proceeding, IEDC and Richter have submitted Offers of Settlement ("Offers"), which the Commission has determined to accept. Solely for the purpose of these proceedings 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 Respondents admit the jurisdiction of the Commission over them and over the subject matter of this proceeding, IEDC and Richter consent to the issuance of this Order Instituting Proceeding ("Order") and to the entry of the findings and the imposition of the relief set forth below. III. On the basis of this Order and Respondents' Offers, the Commission finds the following: A. RESPONDENTS Jerome B. Richter, age 60, resides in Los Altos Hills, California. Richter is the largest shareholder of IEDC, and was its Chairman of the Board and Chief Executive Officer ("CEO") from 1992 to 1994. In December, 1994, he surrendered his title as CEO and Chairman of the Board for that of Secretary/Treasurer. Richter is still a member of the Board of Directors and plays a significant role in the business operations of IEDC. International Energy Development Corporation is a Delaware Corporation with executive offices in Redwood City, California. IEDC operates a liquid petroleum gas ("LPG") distribution facility and pipeline in Brownsville, Texas. IEDC (which subsequent to the opening of this investigation changed its name to Penn Octane Corporation) is registered with the Commission pursuant to Section 12(g) of the Exchange Act. The current board of directors is comprised of nine members, the majority of whom are outside directors. On December 4, 1995, IEDC obtained a Small-Cap Listing on the NASDAQ Stock Market. B. CONDUCT LEADING TO IEDC'S INACCURATE FORM 10-QSBs IN FISCAL YEAR 1994 1. Origin of IEDC IEDC is a start-up venture in which the development of accounting controls failed to match the Company's growth as a business. IEDC began its existence on August 27, 1992, as the Kaliningrad Fund, a "blind pool" promoted by Richter, then Chairman of the Board, to explore investment opportunities in the former Soviet Union. The Kaliningrad Fund changed its name to the Russian Fund, and on January 12, 1993, issued 50,000 shares of stock in a registered initial public offering, raising $500,000. During 1993, Richter decided that Russia did not offer promising investment opportunities. Richter then became interested in pursuing various projects in the power and energy business, and he changed the name of the Russian Fund to International Energy Development Corporation. At the time, IEDC was essentially a one person enterprise with no day-to-day operations. Of the IEDC officers designated in the January 12, 1993 prospectus, the President and Chief Operating Officer and the Secretary resigned after the Company changed its focus from Russia and were not immediately replaced. Richter performed all necessary corporate tasks, which were limited because the Company had no operations before its acquisition of Penn Octane. 2. Purchase of Penn Octane Corporation Among the projects that caught Richter's attention was the revival of a dormant liquid petroleum gas pipeline from Brownsville, Texas to Northern Mexico. The Brownsville pipeline project was the sole business activity of Penn Octane Corporation, a privately held Texas corporation. Penn Octane believed the project would enjoy significant cost advantages over the prevailing method of trucking LPG to the interior of Northern Mexico, and it had received some expression of interest from PEMEX, the Mexican national petroleum company. The project also required the construction of storage and distribution facilities in Brownsville. In September 1993, IEDC entered into an agreement to purchase all of the stock of Penn Octane for $315,000 cash, promissory notes in the amount of $200,000, 200,000 shares of IEDC common stock and warrants to purchase 150,000 shares of IEDC stock at $5.00 per share. To finance the acquisition and the proposed Brownsville storage facility, IEDC sold 150,000 shares of preferred stock on September 18, 1993 via private placement to seven investors who were past business acquaintances of Richter. The offering raised $1.5 million, and each $10 share of preferred stock was convertible to 3.33 shares of common stock (6.66 shares of common stock in light of the subsequent June 1994 2:1 stock split). On October 21, 1993, the acquisition was completed and Penn Octane was merged into IEDC. 3. IEDC's Internal Accounting Environment In November 1993, Richter arranged for a bookkeeper to act as IEDC's internal accountant. The bookkeeper, who is not a certified public accountant, was hired as an independent contractor by Capital Resources, the business name used by Richter for his personal affairs. The bookkeeper spent approximately 85 percent of his time on IEDC matters and approximately 15 percent performing accounting functions for CompuProducts, Inc. ("CompuProducts"), an unregistered computer parts vendor owned by Richter and his stepson. a. IEDC's Basic Recordkeeping Flaws From November 1993 through November 1994, IEDC maintained no general ledger and no double entry bookkeeping system. Instead, it attempted to keep track of its balance sheet and cash flow by referring to its check book and bank statements. The accuracy of this method of accounting for cash flow was hampered by the unusual manner in which funds reached IEDC and how those funds were handled once at IEDC. The bookkeeper testified that most cash coming into IEDC was initially deposited into an account maintained by CompuProducts. The CompuProducts account was used as a "master account" from which funds were disbursed to an IEDC "master account", to various CompuProducts "subaccounts", and to a Capital Resources "subaccount." Cash deposited first to the CompuProducts master account included the proceeds from (1) a $1.45 million loan facility obtained in early 1994; (2) $600,000 raised in a Regulation S offering in June 1994; and (3) the repayment by Richter of loans from IEDC. The bookkeeper testified that he did not have a reliable method, independent of Richter, for determining the source of the funds deposited into the CompuProducts account, nor did he regularly have advance notice of the ultimate destination of the funds. He further testified that in some instances small amounts of money that belonged to IEDC were left in the CompuProducts account for use by CompuProducts because it was experiencing cash flow difficulties. No contemporaneous records were kept of such loans, and no advance authorization for such loans was given by the Board of Directors of IEDC. Instead, the bookkeeper, either at Richter's direction or in an effort to ensure that the obligations of both IEDC and Compuproducts were met, transferred funds between the entities' accounts. After the fact, the bookkeeper would attempt to reconcile the bank statements to sort out the loans between the entities and assess the Company's cash position. IEDC did not take steps to correct for the poor accounting controls while preparing its Form 10-QSBs for the quarters ended October 31, 1993, January 31, 1994 and April 30, 1994 (respectively, "First Quarter", "Second Quarter", and "Third Quarter" of the July, 31, 1994 fiscal year). Even though he did not have adequate records from which to compile financial statements, the bookkeeper testified that he prepared the filings as "best as [he] could" because he did not think the accounting was "a major concern of the company at that point." Once the bookkeeper prepared the financial statements, they received no qualitative review. The bookkeeper left each of the Form 10-QSBs for Richter's signature, and Richter testified that he signed each of them assuming that the bookkeeper had prepared them correctly. Richter did not discuss the filings with the bookkeeper and took no steps to confirm their accuracy. b. IEDC's Undocumented Loans to Richter In addition to IEDC's difficulties in keeping track of its cash, IEDC did not maintain a control environment adequate to ensure that all funds were accounted for and used for appropriate purposes. As a result, IEDC failed properly to report in its filings with the Commission substantial loans the Company made to Richter. On November 1, 1993, IEDC transferred $722,000 to Richter. Richter used these funds to purchase common stocks on margin in three securities accounts -- two in his own name and one in IEDC's name. Richter incurred substantial trading losses. The Board of Directors of IEDC had not authorized such transfers in advance, nor does there appear to be any written record of the business purpose for the transfers. IEDC characterized the transfers as loans the Company made to Richter. The bookkeeper documented the transfers as loans and produced notes from Richter to IEDC. The bookkeeper understood that Richter was using the borrowed funds for trading in the stock market. Richter signed additional notes documenting a total outstanding balance of $926,401 as of December 2, 1993. In testimony, Richter also characterized the transfers as loans, but he added that the transfers originally had a different purpose. Richter testified that the funds were transferred to the securities accounts for stock trading for IEDC's benefit. After Richter's trading yielded unrealized losses of several hundred thousand dollars by late December, 1993, Richter decided to repay the losses from his own funds and characterize the transfers as loans. The Form 10-QSB for the Second Quarter ended January 31, 1994 states generally that loans had previously been made to Richter, but that all obligations had been satisfied, in part through the assignment of marketable securities from Richter to IEDC. The Second Quarter Form 10-QSB lists marketable securities with a value of $535,350 as an asset of IEDC. However, the majority of the securities listed were not in the custody of IEDC. Instead, they remained in Richter's account. The subsequent audit performed by a regional accounting firm ("Second Firm") verified that in fact Richter owed $426,879 to IEDC as of January 31, 1994. Similarly, the Third Quarter Form 10-QSB lists marketable securities of $289,356 and does not indicate that Richter had not repaid all obligations to IEDC. Richter's outstanding obligation to IEDC as of April 30, 1994 was $465,891. Subsequently some of the securities were eventually transferred to the IEDC account, while others were sold and the funds transferred to IEDC. All outstanding balances were repaid during the Fourth Quarter of 1994 as construction bills for the $3 million Brownsville facility came due. c. Improper Classification of Penn Octane Lease The lack of adequate information was compounded by the bookkeeper's limited accountancy skills. IEDC's primary asset was a lease on a pipeline from Brownsville to Northern Mexico acquired when IEDC purchased Penn Octane. IEDC inaccurately classified the lease as a capital lease, rather than an operating lease, in all three of its 1994 Form 10-QSBs. The bookkeeper testified that classification and valuation of the lease was beyond his expertise and could not point to any analysis he performed in capitalizing the lease. In fact, the lease had originally been misclassified by the privately held Penn Octane before it was acquired by IEDC and IEDC failed to reclassify the lease in its own financial statements. Whether a lease is classified as an operating lease or capital lease is governed by Statement of Financial Accounting Standards No. 13 ("SFAS 13"). A lease should be classified as a capital lease if "substantially all of the risks or benefits of ownership are deemed to have been transferred." If any of the following four criteria established by SFAS 13 are met, the lease is a capital lease: 1) The lease transfers ownership of the property to the lessee by the end of the lease term; 2) The lease contains an option to purchase the leased property at a bargain price; 3) The lease terms is equal to or greater than 75 percent of the estimated economic life of the leased property; and 4) The present value of the rental and other minimum lease payments equals or exceeds 90 percent of the fair value of the leased property less any investment tax credit retained by the lessor. In its Form 10-QSBs, IEDC classified the lease as a capital lease relying on the fourth criterion. IEDC and its auditors subsequently determined that at least ten percent of the value of the IEDC pipeline remained with its owner. In addition, they determined that the lease did not fit any of the first three criteria of a capital lease. As such, lease should have been classified as an operating lease. In its subsequent restatement IEDC reclassified the lease as an operating lease in each of the three 1994 Form 10-QSBs. The initial misclassification overstated total assets of the company by $3,609,149 in each of the three 1994 Form 10-QSBs: by 123 percent in the First Quarter (as $6,537,308 instead of $2,928,159), 82 percent in the Second Quarter (as $8,022,762 instead of $4,413,613), and 60 percent in the Third Quarter (as $9,632,125 instead of $6,022,976). 4. Resignation of Accountants and Filing of the 1994 Form 10-KSB The First Firm was retained to conduct the year end audit for the fiscal year ended on July 31, 1994 and to assist in the preparation of IEDC's Form 10-KSB for filing with the Commission. As the First Firm proceeded with its audit, it encountered a number of issues on which it questioned IEDC's accounting, such as the treatment of the lease, the loans to Richter, and the basic reliability of the Company's records. The First Firm initially attempted to work through these issues with IEDC, Richter and the bookkeeper. Ultimately, though, the First Firm resigned from the engagement on November 23, 1994, indicating in its Form 8-K that IEDC "lack[ed] the internal controls necessary to develop reliable financial statements." The bookkeeper left IEDC, and a Second Firm was engaged to audit the financial statement for the year ended July 31, 1994. IEDC changed its name to Penn Octane Corporation in February 3, 1995, and ultimately filed its Form 10-KSB for the period ending July 31, 1994 on March 17, 1995. 5. IEDC's Broad Restatement of its Form 10-QSBs During the course of the audit, the Second Firm determined that IEDC's internal accounting control environment and its specific accounting errors had resulted in IEDC's filing financial statements with the Commission that misstated IEDC's financial position in the First, Second and Third Quarters of the fiscal year ended July 31, 1994. Each of the Form 10-QSBs was restated in IEDC's 1994 Form 10-KSB. Attached as Exhibit A is a copy of IEDC's restatement in its Form 10-KSB. As the comparison reveals, almost every item from the initial Form 10-QSBs needed to be restated, including cash and fixed assets. In fact, before the Second Firm prepared IEDC's Form 10-KSB for the 1994 fiscal year, IEDC was forced to review the underlying records and prepare new ledgers and other records to serve as a basis for its quarterly and yearly financial statements. 6. Trading in IEDC Shares An analysis of trading records during the 1994 calendar year indicates little retail activity in IEDC stock. The first trade in IEDC was conducted on May 13, 1994 at a split adjusted price of 4 1/2. The stock traded in a range, with a high of 5 7/8 on August 28, 1994 to a low of 3 1/2 on January 19, 1995, after the resignation of the First Firm. Transactions were conducted primarily on behalf of certain market making firms that did not approve the stock for recommendation to retail customers. Richter sold no stock during the period while the Company's inaccurate financial statements were on file with the Commission. C. LEGAL ANALYSIS 1. The Periodic Reporting Provisions: Section 13(a) of the Exchange Act and Rule 13a-13, thereunder. Section 13(a) of the Exchange Act and Rule and 13a-13 thereunder require issuers of registered securities to file with the Commission accurate quarterly reports. Courts have uniformly held that "the requirement that an issuer file reports under Section 13(a) embodies the requirement that such reports be true and correct." SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1167 (D.C. 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). IEDC violated Section 13(a) and Rules 13a-13 and 12b-20 with its filing of the three inaccurate Form 10-QSBs for the First, Second and Third Quarters of the fiscal year ended July 31, 1994. IEDC restated virtually its entire Form 10-QSBs for the three quarters. The most significant items misstated in the three filings, as detailed above, were Fixed assets, Total assets and Cash. When all changes comprising the restatements were made, Fixed assets had been overstated by 232 to 5,559 percent. Total assets had been overstated by 193 to 230 percent. Cash was restated from positive to negative amounts in both the Second and Third Quarter Form 10-QSBs, from $899,220 to ($65,450) and $109,176 to ($38,872), respectively. In addition, IEDC's financial statements failed to disclose the substantial loans (up to $926,401) taken by Richter. 2. The Books and Records and Internal Accounting Control Provisions: Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. Section 13(b)(2)(A) of the Exchange Act requires issuers to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of its assets. Scienter is not required to establish a violation of Section 13(b). IEDC violated Section 13(b)(2)(A) by maintaining incomplete and inaccurate books and records, which, among other things, materially overstated its Cash, Total assets and Fixed assets during the first three quarters of fiscal 1994. Section 13(b)(2)(B) of the Exchange Act requires issuers to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP. IEDC violated Section 13(b)(2)(B) of the Exchange Act by failing to implement adequate internal controls to account for the financial position of IEDC in accordance with GAAP. By failing to establish even basic accounting practices and procedures, such as a double entry book system, IEDC could provide no assurance that its records could permit preparation of financial statements in conformity with GAAP. 3. Richter's Liability for IEDC's Inaccurate Financial Reporting As CEO, Richter had ultimate responsibility for the accuracy of IEDC's financial statements and he signed all three inaccurate Form 10-QSBs filed with the Commission. Richter's position constitutes "a substantial ground for the inference that he was involved in every important activity" concerning the operation of IEDC. See Steadman v. S.E.C., 603 F.2d 1126, 1135 (5th Cir. 1979). Richter failed to establish an adequate accounting system for IEDC. Instead, he created a corporate environment that ignored the importance of internal accounting controls and accurate recordkeeping. He hired a bookkeeper to act as the Company's accountant, and he failed to provide that bookkeeper with adequate direction and resources. Rather than supervise the preparation of quarterly filings with the Commission, Richter merely signed without review each of the Form 10-QSB's filed by IEDC during its 1994 fiscal year. As a result, Richter caused the Company's violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13, thereunder. See, e.g., In the Matter of Charles W. Wallin, Exchange Act Release No. 37127, 1996 SEC Lexis 1137 *17-18 (holding individual liable for Section 13 violations for failure to establish proper control environment). In addition, Richter violated Rule 13b2-2, as an officer of IEDC, because he omitted to state or caused the Company's accountant to omit to state material facts in connection with the preparation and filing of reports required to be filed with the commission. Richter failed to disclose to the accountant all information regarding the cash position of IEDC and the loans to Richter sufficient for accurate quarterly filings to be made. IV. Based on the foregoing, the Commission finds that: A. IEDC violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder; and B. Richter violated Rule 13b2-2 of the Exchange Act and caused IEDC's violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20 and 13a-13 thereunder. V. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that: A. IEDC cease and desist from committing or causing any violation and any future violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20 and 13a-13 thereunder; and B. Richter cease and desist from committing or causing any violation and any future violation of Rule 13b2-2 under the Exchange Act, and from causing any violation and any future violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20 and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary