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UNITED STATES OF AMERICA
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In the Matter of Hanover Compressor Company
Respondents. |
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ORDER INSTITUTING CEASE-AND-DESIST PROCEEDINGS, MAKING FINDINGS, AND IMPOSING A CEASE-AND-DESIST ORDER PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934 |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate that cease-and-desist proceedings be, and hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Hanover Compressor Company ("Respondent," "Hanover," or "the Company") and Williams S. Goldberg ("Respondent" or "Goldberg").
II.
In anticipation of the institution of these proceedings, Respondents have submitted Offers of Settlement (the "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 to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over them and over the subject matter of these proceedings, which are admitted, Respondents consent to the entry of this Order Instituting Cease-and-Desist Proceedings, Making Findings, and Imposing a Cease-and-Desist Order Pursuant to Section 21C of the Securities Exchange Act of 1934 ("Order"), as set forth below.
III.
On the basis of this Order and Respondents' Offers, the Commission finds that:1
Respondents
1. Hanover Compressor Company is a Delaware corporation based in Houston, Texas, that has been engaged in the manufacture, rental and operation of oil field equipment, primarily natural gas compressors, since its 1990 formation. Hanover's common stock is registered with the Commission under Section 12(b) of the Exchange Act and trades on the New York Stock Exchange. Hanover's stock has been publicly traded since the Company's 1997 initial public offering.
2. William S. Goldberg, 45, of Winnetka, Illinois, served as a Hanover director from 1991 through August 31, 2002, as its executive vice president from 1991 through early 2002, and as its interim CFO from mid-2000 through January 2002. Goldberg received an MBA degree, but is not an accountant or CPA. Goldberg, among others, was responsible for Hanover's internal controls.2
Summary
3. As described below, serious internal controls deficiencies as well as misconduct by certain former senior executives led to Hanover's violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.3 These failings, some of which began prior to Goldberg's role as interim CFO, resulted in Hanover materially overstating pre-tax income included in its Forms 10-K for fiscal 1999 and fiscal 2000 and its Forms 10-Q for the first, second and third quarters of 2000 and the second and third quarters of 2001, and materially understating the pre-tax income included in its Form 10-Q for the first quarter of 2001. During a special inquiry Hanover conducted during 2002,4 the Company announced three restatements that reduced Hanover's pre-tax income by $3.123 million, or 4.9%, for fiscal 1999, by $14.4 million, or 15.5%, for fiscal 2000, and by as much as $5.5 million, or 22.6%, in an individual quarter.5 Goldberg, among others, failed adequately to address Hanover's internal controls deficiencies in light of the Company's rapid growth and to adequately review the facts and circumstances underlying various transactions, and, consequently, was a cause of Hanover's violations.
Internal Control Deficiencies
4. Hanover grew rapidly throughout its history, in substantial part through acquisitions, and its growth was most pronounced in 2000 and 2001, when the Company tripled in size, from $756 million in assets and $323 million in revenues at year end 1999 to $2.3 billion in assets and $1 billion in revenues at year end 2001. The Company failed, however, to effectively integrate its acquisitions from a management and accounting perspective. Hanover had approximately 30 different accounting systems, which its employees manually consolidated. Moreover, the Company lacked adequate accounting personnel-although Goldberg made efforts to hire additional staff, the staffing levels were not increased sufficiently as the Company grew. Furthermore, Goldberg, the Company's interim CFO beginning in mid-2000, had a limited accounting background and experience, and the company did not have an overall controller. Additionally, the company did not have an internal legal staff to provide consistent documentation and processes for handling large transactions. Finally, to the extent that Hanover had internal controls procedures, they were not adequately enforced. Despite advice from its outside auditor, Goldberg and Hanover's management did not adequately strengthen the Company's internal controls to deal with the changing size and nature of its operations and they were slow to implement improvements in staffing and internal controls. Hanover's poor internal controls caused or contributed to its improper recording of numerous transactions, including approximately 17 transactions involved in its restatements, several of which occurred prior to Goldberg becoming the interim CFO. Goldberg, among others, was a cause of the deficient internal controls that contributed to Hanover improperly recording the transactions that were later restated.
Hanover's Sale of Equipment to a Joint Venture for a Project in Nigeria
5. The most significant of the approximately 17 restated transactions was Hanover's sale of equipment to a joint venture which was to own a gas compression plant on barges in Nigeria. In 1999, prior to Goldberg becoming the interim CFO, Hanover entered into agreements with a Nigerian company to design, construct and operate offshore barges to provide gas compression and processing services in Nigeria. In late 1999, Hanover sought advice from its auditor about structuring a sale of an interest in the project to allow for gain recognition on the sale. Hanover's auditor warned the company that it could recognize revenue from the Nigerian venture only if it received cash, had no obligations to return the cash, and did not guarantee debt. Hanover sought a partner for the project to spread some of the risk on the project and to recognize revenue, and sought to complete the transaction with its prospective partner by the end of the third quarter 2000 so that it could include the transaction in earnings for the quarter. On September 30, 2000, a Hanover subsidiary entered into a $51 million contract to design and construct equipment for a limited liability company (the "LLC") that was 25% owned by Hanover and 75% owned by a third party (the "venture partner"). The LLC, in turn, was to lease the barges and other equipment to the Nigerian company. Hanover recorded revenue on the construction contract under the percentage-of-completion method, after eliminating 25% of the profit to reflect its 25% ownership position in the LLC. In the third quarter 2000, Hanover recorded $2.9 million in pre-tax income from the equipment sale, representing over 11.7% of its pre-tax quarterly income. In the fourth quarter 2000, Hanover recorded $1.2 million in pre-tax income and capitalized $500,000 in expenses related to the equipment sale, thereby increasing its pre-tax fourth quarter 2000 income by 5.6%. In total, Hanover recognized $4.6 million in pre-tax income and capitalized expenses related to the equipment sale in fiscal 2000, equivalent to approximately 5% of its pre-tax income for the year.
6. When the sale of equipment ultimately closed on September 30, 2000, Hanover entered into a loan commitment letter that obligated Hanover to loan the balance of the purchase price to the joint venture if third party financing could not be obtained. In addition, in order to induce the venture partner to make the down payment in early November 2000, Hanover entered into a Guarantee of Refund (the "Guarantee"), which obligated Hanover to return the down payment, with interest and expenses, under certain circumstances. Hanover's CEO and COO, however, did not disclose these agreements to the Company's accountants or, consequently, its auditors, and the Company failed to disclose these facts in its Commission filings.
7. Because of Hanover's Guarantee of the down payment and its commitment to provide financing, the company should not have recognized revenue on the sale of the barges and equipment to the LLC. First, Hanover effectively guaranteed the venture partner's equity investment, and thus was the only true investor in the LLC. Consequently, the LLC should have been consolidated into Hanover's financial statements, effectively eliminating recognition of any revenue from the sale of the equipment. Second, even if the LLC were not a consolidated entity, Hanover's sale of equipment to the LLC should not have been treated as a sale, because Hanover retained substantial risks of ownership in the property sold.6 As a result of these undisclosed agreements, Hanover failed to account for the transaction in accordance with GAAP in recording income from the sale of equipment to the LLC, and the Company materially overstated the pre-tax income for the third and fourth quarters 2000 and fiscal 2000 that it reported in its Form 10-K for fiscal 2000 and its Form 10-Q for the third quarter 2000.
8. In early February 2001, the venture partner notified Hanover in writing that it was exercising the Guarantee. Hanover initially obtained an extension of time in return for paying the venture partner interest and expenses pursuant to the Guarantee. In March 2001, however, when the extension of time was running out, Hanover in substance returned the down payment through the guise of a short-term, unsecured $4 million "loan" to an affiliate of the venture partner. Subsequently, another partner replaced the venture partner, but in February 2002, after Hanover began its special inquiry, the company repurchased the substitute partner's interest.
Turbine Sales
9. Among the other significant transactions included in Hanover's restatements were sales of three turbines during the fourth quarter 2000 and the second and third quarters 2001. In each of these sales, the turbines remained under Hanover's control, either at Hanover facilities or in a third-party storage facility rented by Hanover, and Hanover's COO entered into undisclosed side arrangements, including indirect funding of some payments on the turbines, that precluded revenue recognition on the sales under GAAP.7 Consequently, Hanover's pre-tax income for the fourth quarter and fiscal 2000 and the second and third quarters 2001 was materially overstated in the company's Form 10-K for fiscal 2000 and Forms 10-Q for the second and third quarters 2001.
The Frame 6 Turbine Sale
10. In December 2000, Hanover supposedly sold a Frame 6 turbine for $7.5 million to an affiliate of its venture partner, and the company later arranged the assignment of the contract to other "purchasers." Hanover recorded pre-tax income of $1.3 million from this turbine sale, representing 4.2% of its fourth quarter 2000 pre-tax income and 1.4% of its fiscal 2000 pre-tax income. Ultimately, however, Hanover did not sell the Frame 6 turbine, but instead exchanged it for a partial ownership interest in a Frame 7 turbine.
11. Although Hanover received a 10% down payment from one of the Frame 6 turbine "purchasers," a number of circumstances show that Hanover did not effectively transfer ownership of or risks associated with the Frame 6 turbine, that it retained specific performance obligations on the turbine after the purported sale, and that collectibility of the resulting receivable was not reasonably assured, thereby precluding revenue recognition on the transaction. In particular: (1) a senior officer orally committed Hanover to a profit-splitting and commission arrangement with the initial "purchaser" of the turbine; (2) Hanover made virtually all of the efforts to sell the turbine for each of the "purchasers"; and (3) Hanover indirectly funded a $250,000 interim payment on the Frame 6 turbine in June 2001, when payment on the turbine was overdue. Finally, in late December 2001, when the Frame 6 turbine receivable was long overdue, Hanover agreed to purchase a 51% interest in a Frame 7 turbine for $8 million, and for the Frame 7 seller to then purchase the Frame 6 turbine for $8 million, which was primarily applied to Hanover's overdue receivable. Thus, Hanover essentially exchanged the Frame 6 turbine for an equivalent interest in a Frame 7 turbine. Hanover's COO, however, did not disclose these facts to the Company's accountants or, consequently, its auditors, and the Company failed to disclose these facts in its Commission filings.
The LM6000 Turbine Sales
12. During the second quarter 2001, Hanover recorded the sale of an LM6000 turbine for $16.1 million, recognizing pre-tax income of $1.8 million, or 4.7% of the second quarter 2001 income. The purchaser made a 10% down payment on the LM6000 in April 2001, but revenue recognition was inappropriate because Hanover did not effectively transfer ownership or risks, it retained specific performance obligations on the turbine after the purported sale, and collectibility of the receivable was not reasonably assured. In particular: (1) a senior officer represented that the purchaser would make a 20-30% profit in 45 days or less on his 10% down payment; (2) he promised that Hanover would help the purchaser, who no longer had an active business, sell the turbine on behalf of the purchaser; (3) Hanover made virtually all efforts to sell or finance the turbine on behalf of the purchaser; and (4) Hanover personnel stored, modified and maintained the turbine as if it were still owned by Hanover. In addition, in the third quarter 2001, the purchaser refused to make an additional payment on the turbine, and a Hanover officer funded the interim payment that Hanover received. Hanover's COO, however, did not disclose any of these facts to the Company's accountants or, consequently, its auditors, and the Company failed to disclose these facts in its Commission filings. The $14.5 million receivable from the second quarter 2001 LM6000 sale was not paid off until December 2001, when Hanover obtained a $12 million line of credit and effectively guaranteed the performance of a third party in order for the receivable to be paid.
13. In the third quarter of 2001, Hanover sold a second LM6000 turbine for $17.5 million, recording pre-tax income of $2.8 million, or 7.8% of its third quarter 2001 pre-tax income, but revenue recognition was not appropriate in the third quarter 2001 for a number of reasons. First, although the documents for the sale were dated at the end of the third quarter, they were not drafted or signed until October 2001. Second, in mid to late October 2001, the purchaser advised Hanover that the purchaser had not been able to locate investors to fund the $2 million down payment, and Hanover ultimately indirectly funded the $2 million down payment.8 Thus, Hanover did not effectively transfer ownership or risks in the third quarter 2001 sale of the second LM6000, it retained specific performance obligations on the turbine after the purported sale, and collectibility of the third quarter 2001 LM6000 receivable was not reasonably assured, which precluded revenue recognition on the transaction. Hanover's COO, however, did not disclose any of these facts to the Company's accountants or, consequently, its auditors, and the Company failed to disclose these facts in its Commission filings.9
Violations
14. As a result of the conduct described above, Hanover violated Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder, and Goldberg was a cause of Hanover's violations of these provisions. Section 13(a) of the Exchange Act requires issuers to file periodic reports with the Commission containing such information as the Commission prescribes by rule. Exchange Act Rule 13a-1 requires issuers to file annual reports, while Rule 13a-13 requires issuers to file quarterly reports. Under Exchange Act Rule 12b-20, such reports must contain, in addition to disclosures expressly required by statute and rule, such other information as is necessary to ensure that the statements made are not materially misleading under the circumstances. Section 13(b)(2) of the Exchange Act requires issuers to maintain an adequate system of internal controls and to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and disposition of the assets of the issuer.
Hanover's Remedial Efforts
15. In determining to accept Hanover's Offer, the Commission considered the remedial efforts promptly undertaken by Hanover, and cooperation afforded the Commission staff.
IV.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in the Offers of Hanover and Goldberg.
Accordingly, it is hereby ORDERED that:
A. Respondent Hanover cease and desist from committing or causing any violations and any future violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
B. Respondent Goldberg cease and desist from causing any violations and any future violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.
By the Commission.
Jonathan G. Katz
Secretary
____________________________
| 1 | The findings herein are made pursuant to Respondents' Offers of Settlement and are not binding on any other person or entity in this or any other proceeding. |
| 2 | As disclosed in Hanover's 2000 and 2001 proxy statements, Goldberg did not receive remuneration from Hanover, other than Hanover stock options granted to him in 1998. Instead, Goldberg was employed and paid by a partnership that was the general partner of Hanover's largest shareholder. Goldberg lives in the Chicago area and commuted to Texas throughout his association with Hanover. |
| 3 | On December 18, 2003, the Commission filed a district court action against additional former senior Hanover officers seeking a permanent injunction, civil penalties and additional relief. In a separate district court action, Goldberg consented, without admitting or denying the allegations of the complaint, to the imposition of a civil penalty. See Litigation Rel. No. 18514 (December 18, 2003). |
| 4 | After a financial publication and a stock analyst began questioning Hanover's reporting relating to its joint venture for a project in Nigeria, Goldberg initiated Hanover's internal inquiry. |
| 5 | A restatement announced in February 2002 was included in Hanover's 10-K for the year ended December 31, 2001, filed April 16, 2002, and restatements announced in August and October 2002 were included in amended Hanover Forms 10-K for the years ended December 31, 1999-2001, filed November 21, 2002 and December 23, 2002. |
| 6 | Under Paragraph 21 of FASB Statement of Financial Accounting Standards No. 13 (Accounting for Leases) ("FAS 13"), a seller cannot treat the sale of property that is intended to be leased by the purchaser to a third party as a sale if the seller retains substantial risks of ownership in the leased property. Hanover's guarantee to refund the venture partner's down payment and Hanover's commitment to loan the LLC the balance of the purchase price created substantial risk of ownership in the 75% of the LLC that Hanover did not already own. Therefore, Hanover's sale of barges and equipment to the LLC should have been accounted for as a borrowing rather than a sale. FAS 13, ¶ 22. |
| 7 | Revenue typically is realized or realizable and earned when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller's price to the buyer is fixed or determinable; and (4) collectibility is reasonably assured. See Statement of Financial Accounting Concepts ("SFAC") No. 2, Qualitative Characteristics of Accounting Information, ¶ 63; SFAC No. 5, ¶¶ 83-84; Statement of Position 97-2, Software Revenue Recognition, ¶¶ 8, 26, 30-33; ARB No. 43, Chapter 1A, ¶ 1; APB Opinion No. 10, ¶ 12; Statement of Financial Accounting Standards No. 66, Accounting for Sales of Real Estate, ¶¶ 18, 28; Staff Accounting Bulletin 101, Revenue Recognition in Financial Statements (Dec. 3, 1999) ("SAB 101"). SAB 101 summarizes some of the requirements the Commission has articulated for recognition of revenue when delivery has not occurred, i.e. on a "bill and hold sale," including: "(1) The risks of ownership must have passed to the buyer; ... (3) The buyer, not the seller, must request that the transaction be on a bill and hold basis. The buyer must have a substantial business purpose for ordering the goods on a bill and hold basis; ... (5) The seller must not have retained any specific performance obligations such that the earnings process is not complete; ...." Each of Hanover's turbine sales failed to meet one or more of the general criteria for recognition of revenue or the criteria specifically applicable to bill and hold sales. |
| 8 | In addition, Hanover signed letters of intent to make an equity investment in the South American project in which the second LM6000 turbine was to be used, and did virtually no due diligence on the purchaser, whose principal was a paid Hanover consultant officed at Hanover's Dallas facilities. |
| 9 | Goldberg, who authorized Hanover's recording of the income from the second LM6000 sale, did so without seeking and obtaining adequate information about the underlying transactions. |
http://www.sec.gov/litigation/admin/34-48951.htm
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