CORRECTED VERSION OF ORDER AS OF 4/26/99 --- INCORRECT VERSION OF ORDER APPEARED ON THIS SITE FROM 4/21/99 TO 4/23/99 UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 41313 / April 20, 1999 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 1127 / April 20, 1999 ADMINISTRATIVE PROCEEDING File No. 3-9878 ________________________________ : In the Matter of : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF : : 1934, MAKING FINDINGS AND LARRY L. SKAFF and JOHN F. : IMPOSING A CEASE-AND- LIECHTY, : DESIST ORDER : Respondents. : : ________________________________: I The Securities and Exchange Commission ("Commission") deems it appropriate to institute public administrative proceedings, pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), against Larry L. Skaff ("Skaff") and John F. Liechty ("Liechty"). II In anticipation of the institution of these administrative proceedings, Skaff and Liechty each have submitted an Offer of Settlement which the Commission has determined to accept.[1] 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 the subject matter of the proceeding, which are admitted, Skaff and Liechty consent to the entry of this Order Instituting Proceedings pursuant to Section 21C of the Exchange Act, Making Findings and Imposing a Cease-and-Desist Order. Accordingly, it is ordered that proceedings pursuant to Section 21C of the Exchange Act be, and hereby are, instituted. III On the basis of this Order and Respondents Offers of Settlement, the Commission makes the following findings: A. STATEMENT OF FACTS 1. Summary For the fiscal years ended December 31, 1989, through 1992, Fruehauf Trailer Corporation ("Fruehauf") and Terex Corporation ("Terex") misstated their financial condition in public filings in violation of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder.[2] Among others, Skaff and Liechty were causes of Fruehauf's and Terex's violative conduct through August 1992 and June 1993, respectively. By improperly applying purchase accounting rules following Terex’s 1989 acquisition of Fruehauf, Skaff and Liechty, among others, caused Fruehauf and Terex to overstate its pre-tax earnings by approximately $77.3 million from the time of the acquisition through its fiscal year ended December 31, 1992. Fruehauf's financial condition was primarily misstated by improperly excluding losses of certain subsidiaries held for sale from its consolidated earnings and through the use of undisclosed reserves established as purchase accounting adjustments. Skaff and Liechty, among others, caused Fruehauf and Terex to misstate purchase accounting reserves. Fruehauf, Skaff and Liechty, among others, mischaracterized positive trends as the result of successful restructuring efforts rather than accounting adjustments. In addition, Fruehauf, Skaff and Liechty, among others, failed to disclose or inadequately disclosed the impact of an adjustment of a pension liability and the short-term nature of a bank debt. 2. Respondents a. Larry L. Skaff is 57 years old and resides in Green Bay, Wisconsin. Skaff was the chief financial officer of Terex from March 1987 through August 1992. b. John F. Liechty is 50 years old and resides in Lompoc, California. Liechty was the chief financial officer of Fruehauf from May 1990 through early June 1993. Many of the facts alleged herein pre-date Liechty's tenure at Fruehauf. 3. Background Information a. The Fruehauf Acquisition On July 14, 1989, Terex, through a subsidiary, acquired the trailer operations and certain other assets and liabilities of Fruehauf Corporation for approximately $231.3 million consisting of $171 million in cash, a $6.5 million promissory note and the assumption of $53.8 million in liabilities. As the acquiring company, Terex assumed control over the assets and operations acquired from Fruehauf and accounted for the acquisition under the purchase method as provided for in Accounting Principles Board Opinion No. 16, "Business Combinations" ("APB No. 16"). In accounting for the acquisition, Fruehauf, Skaff and Liechty, among others, failed to follow the guidance provided by APB No. 16 and other relevant accounting literature and thereby overstated Fruehauf's pre-tax earnings by $77.3 million from the time of the acquisition through its fiscal year ended December 31, 1992. b. Fruehauf's Restated Financial Statements On March 11, 1994, Fruehauf advised the staff of the Commission's Division of Corporation Finance that its prior auditor refused to reissue updated audit reports for inclusion in certain Fruehauf registration statements pending before the Commission. Furthermore, the prior auditor notified Fruehauf that its previously issued unqualified audit reports on Fruehauf's 1989, 1990 and 1991 financial statements could no longer be relied upon. On March 31, 1994, Fruehauf issued a Form 8-K announcing that it would review its accounting for the acquisition, restate its financial statements for 1989 through 1992 (the "Restatement") and that its financial statements for the years ended December 31, 1989 through 1992 could no longer be relied upon. The Restatement focused primarily on (1) the accounting treatment afforded certain businesses held for sale, (2) the recording of certain restructuring reserves in the purchase price allocation and charges related thereto and (3) the valuation of certain assets. On March 9, 1995, Fruehauf filed its Form 10-K for the year ended December 31, 1993, and on March 17, 1995, filed its Forms 10-Q for the periods ended March 31, June 30, and September 30, 1994. These filings included the impact of Fruehauf's restated consolidated financial results from the date of the acquisition through December 31, 1992. The following is a summary of the Restatement's effects on Fruehauf's net income: Reported Restated Net income Net income Year (loss) (loss) Difference 1989 $ (191,000) $ 1,554,000 $ 1,745,000 1990 (2,176,000) (51,066,000) (48,890,000) 1991 (28,876,000) (73,125,000) (44,249,000) 1992 (65,160,000) (47,448,000) 17,712,000 Total $(96,403,000) $(170,085,000) $(73,682,000) The increase in 1989 net income resulted from a number of adjustments primarily related to group insurance costs and reduced depreciation costs resulting from lower valuations assigned to certain noncurrent assets, including fixed assets. Such items were partially offset by, among other things, revised treatment for restructuring-related costs. The increase in 1990 and 1991 losses resulted primarily from the revised accounting treatment for Fruehauf's restructuring-related costs and the inclusion of previously excluded losses of businesses held for sale. The decrease in 1992 losses resulted from reduced depreciation costs and revisions to fixed asset impairment writedowns and asset sale gains/losses resulting from lower valuations assigned to fixed assets. **FOOTNOTES** [1]: In determining to accept respondents' Offer of Settlement, the Commission considered remedial acts promptly undertaken by the respondents and cooperation afforded the Commission staff. [2]: Prior to Fruehauf's June 1991 initial public offering ("IPO"), the misstatements relating to Fruehauf's operating results and financial condition appeared in the financial statements of Terex Corporation ("Terex") via consolidation. Beginning with Fruehauf's April 16, 1991, initial registration statement, which became effective on June 28, 1991, the misleading information was included in Fruehauf's own filings as well as Terex's filings with the Commission. Terex ceased consolidation of Fruehauf in 1992. c. Fruehauf's Post-Restatement Filings On March 31, 1995, Fruehauf filed its annual report on Form 10-K for the year ended December 31, 1994. During the year ended December 31, 1995, it filed all reports required to be filed on Form 10-Q, and on February 28, 1996, filed its annual report on Form 10-K for the year ended December 31, 1995. Through October 7, 1996, the date on which Fruehauf filed for protection under Chapter 11 of the Bankruptcy Code, Fruehauf filed its quarterly reports on Form 10-Q for the periods March 31, June 30 and September 30, 1996. Subsequent to October 7, 1996, and while still subject to its bankruptcy proceedings, Fruehauf, in lieu of filing its annual and periodic reports, has filed with the Commission under cover of Form 8-K, monthly reports filed with the Bankruptcy Court. 4. Accounting Issues and Relevant Generally Accepted Accounting Principles APB No. 16 is the authoritative literature under generally accepted accounting principles ("GAAP") for business combinations, including the acquisition of Fruehauf by Terex. APB No. 16 specifies that the cost of an acquired company should be allocated to the assets acquired and liabilities assumed based on their respective fair values at the date of acquisition. The accounting issues related to the Fruehauf acquisition primarily concern the identification and treatment of assets expected to be sold and the type of costs that may be recorded as liabilities assumed in the acquisition. GAAP normally require application of the "all-inclusive" income statement concept. This concept recognizes all income and expenses, even irregularly occurring losses or costs, in the results of operations in the period incurred, unless GAAP provide otherwise. This "all-inclusive" concept is intended, among other things, to avoid discretionary omissions of losses or gains from income, thereby avoiding a presentation of a more or less favorable report of performance than is justified. See Statement of Financial Accounting Concepts No. 5, "Recognition and Measurement in Financial Statements of Business Enterprises," paragraph 35. As described in more detail below, when accounting for the acquisition of one company by another, GAAP carve out certain exceptions to this "all-inclusive" income statement notion. One such exception is for costs expected to be incurred in connection with assets acquired in a business combination which management, at the time of the acquisition, has determined will be sold within a year of the acquisition date. In this special situation, GAAP provide that subsequent earnings or losses from these assets are not to be reflected in the consolidated statement of operations but as part of the carrying value of the asset held for sale. Another exception to the "all-inclusive" income statement concept relates to certain costs that should be capitalized as part of the purchase price. GAAP provide that assumed liabilities, whether or not shown on the acquired company's financial statements, should be considered when accounting for the acquisition. Thus, previously unrecorded liabilities should be recorded if they represent obligations at the date of purchase. Further, certain expected future costs related to the closing of facilities should, in certain circumstances, be recorded as liabilities assumed in the acquisition. However, costs which are not obligations at the date of purchase should not be recorded. Instead, these costs should be accounted for when incurred in the periods subsequent to the business combination. a. Fruehauf's Accounting for Certain Assets Held for Sale When assets of an acquired business are identified as held for sale, Financial Accounting Standards Board ("FASB") Emerging Issues Task Force Issue No. 87-11, "Allocation of Purchase Price to Assets to be Sold" ("EITF No. 87-11") requires those assets to be recorded at a value equal to their expected cash flows from operations from the date of the acquisition until the date of sale (not to exceed one year), less interest on incremental debt incurred to finance the asset (for a period not to exceed one year), plus anticipated sales proceeds. Subsequent earnings or losses related to these assets within one year are excluded from consolidated earnings because they should be reflected as adjustments of the carrying value of the asset held for sale. To account for an asset pursuant to EITF No. 87-11, the following conditions must be satisfied: (1) the asset must be identified at the purchase date as held for sale and, at that date, there must be a reasonable expectation of sale within one year of the date of acquisition; and (2) the asset to be sold must constitute a line of business or a portion of a line of business as defined by APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("APB No. 30"), and the American Institute of Certified Public Accountants Accounting Interpretation No. 1, "Illustration of the Application of APB Opinion No. 30" ("Interpretation No. 1 of APB No. 30"). Furthermore, EITF Issue No. 90-6, "Accounting for Certain Events Not Addressed In Issue No. 87-11 Relating to an Acquired Operating Unit to Be Sold" ("EITF No. 90-6"), requires a company to discontinue accounting for assets under EITF No. 87-11 and include earnings or losses from such assets in its income statement if these assets are not sold within one year from the date of the acquisition. As described more fully below, Skaff and Liechty, among others, caused Fruehauf to improperly account for certain businesses held for sale acquired in the combination. In some instances, Fruehauf continued to apply EITF No. 87-11 accounting after it became apparent that assets would not be disposed of within the time frame required. In other cases, Fruehauf retroactively applied EITF No. 87-11 accounting to assets which were not originally designated as held for disposal. Furthermore, Fruehauf failed to discontinue application of EITF No. 87-11 accounting for the period ended September 30, 1990, and subsequent periods as required under EITF No. 90-6. The misapplication of the "assets held for sale" accounting resulted in an overstatement of Fruehauf's 1990, 1991 and 1992 pre-tax earnings by $19.9 million, $12.9 million and $2.6 million, respectively. (1) Maritime Businesses At or around the time of the acquisition, Fruehauf announced its intention to divest itself of Jacksonville Shipyards, Inc. and Coast Engineering and Manufacturing Company (collectively, the "Maritime Businesses") which were acquired in the acquisition. Fruehauf was required to account for its investment in the Maritime Businesses pursuant to EITF No. 87-11. Fruehauf failed to dispose of the Maritime Businesses within one year of the acquisition. Contrary to the guidance provided by EITF No. 90-6, however, Skaff and Liechty, among others, caused Fruehauf to continue to exclude the majority of operating losses from these businesses from consolidated earnings through 1992. The exclusion of these operating losses from consolidated earnings resulted in the overstatement of Fruehauf's 1990, 1991 and 1992 pre-tax earnings by $19.8 million, $11.9 million and $1.2 million, respectively. (2) Decatur Businesses In June 1990, Fruehauf decided to divest itself of the Decatur Extrusion Company and Fruehauf's 50% interest in the Decatur Aluminum Company (together, the "Decatur Businesses"), two assets obtained in the acquisition. In September 1990, Fruehauf retroactively adjusted the allocation of the purchase price to account for the Decatur Businesses under EITF No. 87-11. Fruehauf's exclusion, with the approval of Skaff and Liechty, of the operating losses of the Decatur Businesses was not appropriate under EITF No. 87-11 since Fruehauf had not identified the Decatur Businesses at the acquisition date as assets to be sold. As a result of Fruehauf's improper accounting for the Decatur Businesses' operating losses, Fruehauf overstated its 1990, 1991 and 1992 pre-tax earnings by $146,000, $943,000 and $1.4 million, respectively. b. Fruehauf's Purchase Accounting Reserves In accounting for the acquisition, Skaff, among others, caused Fruehauf to establish reserves for future costs. Skaff and Liechty, among others, caused Fruehauf to then understate expenses of subsequent periods by improperly charging costs incurred in the restructuring and downsizing of its trailer business against these reserves instead of reflecting the costs as operating expenses in the income statement. Recording future costs as liabilities assumed in an acquisition directly impacts earnings subsequent to the acquisition. When liabilities are recorded in purchase accounting, certain subsequent expenditures are recorded as reductions in these liabilities instead of being recognized as current period expenses. This exclusion of expenses from the results of operations increases reported earnings. Paragraph 87 of APB No. 16 provides that assumed liabilities, even if previously unrecorded, should be recorded in purchase accounting if they represent liabilities at the date of acquisition.[3] Further, GAAP provide that certain costs related to closing facilities after the acquisition should be recorded as liabilities assumed in the acquisition. Specifically, paragraph 88(i) of APB No. 16 states that a company should record as liabilities unfavorable leases, contract commitments and "plant closing expense incident to the acquisition," i.e., those costs directly attributable to the closing of facilities of the acquired company.[4] Plant closing expense does not include costs that benefit activities to be continued or costs which are related to the ongoing revenue-generating activities of a company. Examples of such ongoing revenue-generating expenses include costs of purchasing new computers, consulting fees, retraining costs for employees that will be part of a company's ongoing activities, as well as costs of packing and moving inventory and equipment from one facility to another. Also, plant closing expense does not include costs which are incurred to improve operating efficiencies. These may include, for example, costs of developing new software that will enable the remaining personnel to work more efficiently. As described below, Skaff, among others, caused Fruehauf to improperly charge to these restructuring reserves expenses of approximately $1.1 million in 1989 and Skaff and Liechty, among others, caused Fruehauf to improperly charge to these restructuring reserves expenses of approximately $25.7 million, $14.0 million and $1.1 million in 1990, 1991 and 1992, respectively. (1) Plant Restructuring Costs In July 1989, Fruehauf established two reserve accounts entitled "Reserve for Plant Variance" and "Reserve for Plant Shutdown." From July 1989 through December 1991, Skaff, among others, and from early June 1990 through December 1991, Liechty, among others, caused Fruehauf to charge to these purchase accounting reserves, among other costs, manufacturing variances incurred (1) during the wind-down of operations at plants to be closed and (2) at plants which were not closed but which received transferred product lines. In addition, Skaff and Liechty, among others, caused Fruehauf to improperly charge to the Reserve for Plant Shutdown a portion of the costs related to Fruehauf's 1991 restructuring plan.[5] Fruehauf's accounting for the manufacturing variances at the receiving plants did not comply with GAAP because the variances were simply operating costs that GAAP required to be expensed as period costs. Fruehauf failed to apply the accounting required by EITF No. 87-11 to the closed plants that were identified at the acquisition date as assets held for sale. Charging certain manufacturing variances incurred by the closed plants to the plant restructuring reserves, reduced losses or generated income that were improperly reflected in Fruehauf's results of operations. The failure to account for the plants expected to be closed under EITF No. 87-11 resulted in the overstatement of Fruehauf's earnings. As a result of its improper utilization of the purchase accounting reserves for Plant Variance and Plant Shutdown, Skaff and Liechty, among others, caused Fruehauf to understate its operating expenses and overstate its pre-tax earnings by $14.3 million and $7.2 million in 1990 and 1991, respectively. (2) Corporate Restructuring Costs Subsequent to the acquisition, Fruehauf recorded as purchase accounting adjustments reserves entitled "Corporate Restructuring," "MIS Restructuring" and "Home Office Moving Reserve." From July 1989 through December 1992, Fruehauf utilized these accounts by charging to them certain "excess" MIS and home office costs and other miscellaneous items. Fruehauf's "excess" costs represented that portion of departmental expenses in excess of Fruehauf's projected post-restructuring monthly costs. Under paragraph 88(i) of APB No. 16 and EITF No. 84-35, only estimated costs directly related to closing acquired facilities are to be recorded as liabilities in purchase accounting. Because neither operating inefficiencies nor savings expected to be realized but not yet attained are assumed liabilities under APB No. 16, Fruehauf's accounting for its "excess" costs did not comply with GAAP. In addition, Fruehauf's accounting was inappropriate because certain costs charged to these reserves were not closing costs, but instead were ongoing operating expenses that GAAP required to be expensed in the period incurred. Fruehauf also improperly charged to these reserves miscellaneous costs incurred subsequent, and unrelated, to the acquisition. For example, Fruehauf improperly charged to these reserves consultant fees, costs incurred for its national sales meeting held in February 1990, special tooling costs and costs related to the decline in value of a marketable security purchased subsequent to the acquisition. By improperly charging recurring period costs to the MIS Restructuring, Home Office Moving and Corporate Restructuring reserves, Skaff, among others, caused Fruehauf to understate its operating expenses and overstate its pre-tax earnings by $1.1 million in 1989 and Skaff and Liechty, among others, caused Fruehauf to understate its operating expenses and overstate its pre-tax earnings by $4.0 million, $5.1 million and $1.1 million in 1990, 1991 and 1992, respectively. **FOOTNOTES** [3]: Whether a particular cost constitutes a liability at the date of acquisition requires a determination of (1) whether there exists a legal, equitable or constructive obligation for the company to sacrifice its assets in the future, and (2) whether that obligation existed at the date of acquisition. Only present obligations, that is, those obligations resulting from a past transaction or event, are liabilities. See Financial Accounting Concepts No. 6, "Elements of Financial Statements, paragraphs 195-206. [4]: According to EITF Issue No. 84-35, "Business Combinations: Sale of Duplicate Facilities and Accrual of Liabilities" ("EITF No. 84-35"), the allocation of the purchase price in a business combination may involve establishing liabilities for plant closings after the combination. However, only the costs of closing a facility acquired via the acquisition may be accrued in purchase accounting. Neither paragraph 88(i) of APB No. 16 nor EITF No. 84-35 specify what type of costs are considered "closing costs." However, analogous accounting guidance is provided by APB No. 30, which identifies closing costs as costs which (a) are a direct result of the decision to dispose of a business segment and (b) are not adjustments or expenses that should be recognized on a going-concern basis. Costs and expenses directly associated with the decision to dispose of a business segment may include items such as severance pay, additional pension costs and future rentals on long-term leases to the extent they are not offset by sub- lease rentals. [5]: In 1991, Fruehauf initially recorded a $15.8 million charge to operations for costs related to the restructuring of its manufacturing operations and distribution system. However, Fruehauf's actual estimate of the cost of this restructuring program was $18.5 million. Fruehauf improperly used the $2.7 million remaining balance in the Reserve for Plant Shutdown to absorb part of its 1991 restructuring plan costs. (3) Branch and Regional Sales Office Restructuring Costs In July 1989, Fruehauf recorded as a purchase accounting adjustment a reserve entitled "Branch Shutdown Reserve." From February 1990 through September 1990, Fruehauf charged to the reserve (1) "excess" operating expenses incurred by its branch and regional sales offices and (2) operating losses and nonrecurring closing costs related to the closing of 23 branch offices from November 1989 through May 1990. For the reasons discussed in the preceding subsection, Fruehauf's accounting for the "excess" branch and regional sales office costs did not comply with GAAP. Also, Fruehauf's accounting for its operating losses and costs related to the closing of 20 of the 23 branch offices did not qualify as closing costs incident to the acquisition under APB No. 16. The guidance of EITF 87-11 describes the only circumstances where operating or closing costs of a business to be disposed of are capitalized as purchase accounting adjustments. As previously discussed, EITF 87-11 requires that a company be able to demonstrate that the operation to be sold had been identified at the purchase date. APB 16, which requires recording a liability for plant closing expense, is limited to items such as lease obligations for unused space. It does not permit capitalization of operating costs. At the date of acquisition, Fruehauf had not committed itself to a formal plan to sell or otherwise dispose of the twenty branch offices. Specific branch offices were not identified for closing until the spring of 1990 when Fruehauf management was replaced and certain Terex representatives were assigned the task of evaluating the potential restructuring activities at Fruehauf. As a result of its improper accounting for its branch and regional sales office restructuring costs, Skaff and Liechty, among others, caused Fruehauf to understate its operating expenses and overstate its pre-tax earnings by $4.6 million and $150,000 in 1990 and 1991, respectively. (4) Parts Distribution Center Moving Costs In December 1989, five months after the acquisition was consummated, Fruehauf recorded as a purchase accounting adjustment a reserve account entitled "Westerville Reserve" for costs associated with transferring the parts distribution functions performed at Fruehauf's Westerville, Ohio facility to Terex's parts distribution center in Southhaven, Mississippi. From January 1990 to June 1991, Fruehauf charged to the reserve "excess" operating expenses and salaries and fringe benefits expenses unrelated to the Westerville facility.[6] Fruehauf's use of the Westerville Reserve did not comply with GAAP. Under paragraph 88(i) of APB No. 16 and EITF No. 84-35, only costs directly related to the closing of an acquired facility may be recorded as a liability in purchase accounting. The "excess" operating expenses and unrelated salary and fringe benefits expenses charged to the Westerville Reserve were not costs of closing the Westerville facility, but instead were ongoing operating costs that GAAP required to be expensed in the period incurred. By charging these expenses to the Westerville Reserve, Skaff and Liechty, among others, caused Fruehauf to understate its operating expenses and overstate its pre-tax earnings by $1.1 million and $576,000 in 1990 and 1991, respectively. (5) Plant Start-up Costs In July 1989, Fruehauf recorded as a purchase accounting adjustment a reserve account entitled "Reserve for Reefer Plant" for costs associated with moving the production of refrigerated van trailers (a.k.a. "reefers") from a closed manufacturing plant to a facility to be constructed in Indianola, Iowa. From June 1990 through April 1991, Fruehauf charged to this reserve Indianola's pre-operating expenses and operating losses incurred until the reserve was depleted in May 1991. Fruehauf's accounting for Indianola's start-up costs did not comply with GAAP. Fruehauf's creation of a reserve as a purchase accounting adjustment reflected an inappropriate characterization of Indianola's start-up costs as plant closing expense. By charging Indianola's start-up costs to a purchase accounting reserve, Skaff and Liechty, among others, caused Fruehauf to understate its operating expenses and inflate its pre-tax earnings by $1.6 million and $1.1 million in 1990 and 1991, respectively. c. Fruehauf's Pension Liability Reversal In September 1990, Fruehauf recorded an additional $10 million pension liability as a purchase accounting adjustment. Fruehauf justified the adjustment by stating that the company had decided to reverse an earlier decision by pre-acquisition management to cap pension benefits. In the first quarter of 1991, Fruehauf attempted to release $3 million of the $10 million accrual into income, but its auditor objected. Fruehauf maintained its intent to lift the cap on pension benefits and, therefore, retained the entire $10 million pension liability at the end of the first quarter of 1991. In the second quarter of 1991, Fruehauf reversed its decision to lift the cap on pension benefits and released the entire $10 million into income with the knowledge and approval of its prior auditors. Skaff and Liechty, among others, caused Fruehauf's accounting for this pension modification to be inconsistent with FAS No. 87, "Employers' Accounting for Pensions," which required the $10 million to be amortized over future periods rather than recorded as a one-time gain in the period of change.[7] Excluding the $10 million, Fruehauf would have reported a loss from operations and an overall net loss of $3.6 million and $8.1 million, respectively, in the quarter immediately prior to Fruehauf's initial public offering. Skaff and Liechty, among others, caused Fruehauf's financial statements not to be in compliance with GAAP. In addition, Fruehauf, Skaff and Liechty, among others, filed a third quarter 1991 Form 10-Q that failed to quantify the pension reversal or explain the reversal’s impact on income. d. Fruehauf's Violation of its Debt Covenants In November 1991, at the time of the filing of its Form 10-Q for the third quarter, Fruehauf had approximately $99.7 million in bank debt. Of this amount, $82.7 million was improperly classified as long-term because the financial institutions were entitled to, among other things, accelerate the loans (i.e. "call" the loan) if Fruehauf failed to meet certain financial ratios. As discussed in the preceding subsection, because Fruehauf had to reverse the improperly recorded $10 million of income during the second quarter 1991, it failed to meet certain of its required ratios in the third quarter and was, therefore, in violation of its loan covenants. Consequently, Fruehauf was required to reclassify the outstanding $82.7 million in loans as a current liability. FAS No. 78, "Classification of Obligations that are Callable by the Creditor," requires that long-term callable obligations shall be classified as current liabilities at the balance sheet date. The current liabilities classification is intended to include long-term obligations that are or will be callable by the creditor because of the debtor's violation of a provision of the debt agreement. A callable obligation does not have to be recorded as a current liability if the creditor waives the right to demand repayment after the balance sheet date but before the financial statements are issued. Liechty and Skaff were aware of the debt covenant violation before they signed Fruehauf's and Terex's third quarter 1991 Forms 10-Q. Liechty and Skaff, among others, caused Fruehauf and Terex to improperly classify Fruehauf's $82.7 million in debt as a long-term obligation.[8] Fruehauf's creditors did not waive their right to demand repayment until March of 1992. Therefore, as of the date the third quarter 1991 financial statements were issued, Skaff and Liechty, among others, caused Terex and Fruehauf to improperly record a callable obligation as a long- term liability. e. Inadequate Disclosures in Fruehauf's Regulatory Filings In addition to failing to comply with GAAP, as discussed above, Fruehauf, Skaff and Liechty, among others, also committed and caused reporting violations by failing to disclose to the public in Management's Discussion and Analysis section of their financial statements that, without the use of purchase accounting reserves, Fruehauf would have sustained losses of $12.4 million and $45.4 million in 1990 and 1991, respectively, instead of showing income of $19.3 million and a loss of only $23.2 million for those same years.[9] Furthermore, even if the purchase accounting had been applied properly, Fruehauf, Skaff and Liechty, among others, failed to inform the public of the way that purchase accounting adjustments were used to greatly enhance Fruehauf's financial picture for 1990 and 1991 in its MD&A. The fact that no further favorable purchase accounting adjustments were expected for periods after 1991 and that Fruehauf's future financial condition would be dependent solely on the actual results of its operations, rather than the income-enhancing application of purchase accounting, was a known trend that would have a material impact on future reported earnings. As a result, the public had no meaningful information concerning the "quality" of Fruehauf's earnings. Thus, Fruehauf represented itself as a financially sound enterprise, rather than as a company which, but for purchase accounting, would be showing enormous losses. f. Failure to Adequately Disclose the Impact of Purchase Accounting Item 303(a) of Regulation S-K, "Management's Discussion and Analysis of Financial Condition and Results of Operations," requires an issuer to provide information with respect to "its liquidity, capital resources and results of operation" as well as other information which is "necessary to an understanding of its financial condition, changes in financial condition and results of operation." Thus, Item 303(a) requires additional disclosures when reported financial information is not indicative of future operating results or financial condition or when required to make the financial information as presented not misleading. "Management's Discussion and Analysis," Exchange Act Release No. 34-26831, ("MD&A Release") § III.E. In other words, Item 303(a) requires that management address any issues which impact the quality of earnings. Specifically, Item 303(a)(3) requires that management "describe any unusual or infrequent events or transactions . . . that materially affected the amount of reported income from continuing operation and in each case, indicate the extent to which income was so affected," and "describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a materially favorable or unfavorable impact on net sales or revenues or income from continuing operations." While an auditor or other third party may review the MD&A section, the substance of the MD&A is the responsibility of management. MD&A Release, § III.A. (emphasis added). For interim reports such as a Form 10-Q, Item 303(b) requires a discussion and analysis of the results of operations to enable the reader to assess material changes in financial condition and results of operations that have occurred since the end of the preceding fiscal year. Instruction 4 to Item 303(b) mandates that discussions of material changes in results of operations must identify any significant elements of the registrant's income or loss from continuing operations which do not arise from or are not necessarily representative of the registrant's business. As described below, Fruehauf, Skaff and Liechty, among others, failed to comply with these requirements in a number of respects. (1) 1990 Income from Operations During 1990, Fruehauf utilized its purchase accounting reserves to absorb operating costs which would otherwise have been charged against operating income. For the year, these purchase accounting adjustments increased Fruehauf's operating income by at least $31.7 million. Fruehauf and Skaff, among others, however, failed to comply with Item 303 of Regulation S-K in that there was no meaningful disclosure in Terex's public filings of the massive, but short-term, impact of purchase accounting on Fruehauf's--and therefore, via consolidation, Terex's--income from operations. For the first quarter of 1990, Terex reported income from Fruehauf's operations of $6.6 million. Without the benefits afforded by purchase accounting, however, Fruehauf would have sustained an operating loss of $1.3 million. Thus, purchase accounting adjustments for the quarter totalled at least $7.9 million. Terex, however, failed to disclose in its Form 10-Q the amount and nature of the purchase accounting adjustments and the likely effect on future earnings and liquidity, as required by Item 303 of Regulation S-K. In other words, Terex and Skaff, among others, failed to disclose that a significant component of Fruehauf's income from operations was the result of purchase accounting adjustments and that such adjustments were not expected to recur beyond the immediate future. Similarly, in the second and third quarters of 1990, Terex reported income from Fruehauf's operations of $5.2 million and $3.8 million, respectively. Without the benefits of purchase accounting, however, Fruehauf would have shown losses from operations of at least $5.2 million and $5.7 million, respectively, for differences of $10.4 million and $9.5 million, respectively. Terex's second and third quarter 1990 Forms 10-Q again failed to make any reference to the significant purchase accounting component of income from operations. For the fiscal year ended December 31, 1990, Terex reported operating income from Fruehauf of $19.3 million. Purchase accounting adjustments for the year, however, totalled at least $31.7 million, meaning that without the benefits of purchase accounting adjustments, Terex would have reported a loss from Fruehauf's operations of approximately $12.4 million. Terex's 1990 Form 10-K failed to disclose that its reported operating earnings were due to the extensive use of purchase accounting adjustments, the amount of these adjustments and that the benefits of purchase accounting were not expected to recur beyond the immediate future. (2) 1991 Income from Operations During 1991, in addition to utilizing purchase accounting reserves to absorb operating costs which would otherwise have been included in operating income, Fruehauf also directly released "excess" balances of a number of purchase accounting reserves into income. For the year, Fruehauf's purchase accounting adjustments increased Fruehauf's operating income by at least $22.3 million. Fruehauf, Skaff and Liechty, among others, ignored Item 303 of Regulation S-K in that they made no disclosures in Fruehauf's or Terex's MD&A sections regarding the amounts of these massive purchase accounting adjustments, the true quality of current income from operations or likely future earnings once the reserves were exhausted. For the first quarter of 1991, the last full quarter prior to the Fruehauf IPO, Fruehauf reported in its registration statement income from operations of $76,000. Without the benefits afforded by purchase accounting, however, Fruehauf would have sustained an operating loss of $6.5 million. Thus, purchase accounting adjustments for the quarter totalled at least $6.6 million. In the MD&A section included in Fruehauf's IPO prospectus, Fruehauf made the following disclosure regarding its operating results in the first quarter of 1991: Income from operations for the first quarter of 1991 was $0.1 million compared to $6.6 million for the first quarter of 1990 due to the decrease in sales volume and increased engineering, selling and administrative expenses. Furthermore, Fruehauf stated that it "remained slightly profitable on an operating basis in the first quarter of 1991, in spite of the lowest level of industry unit sales since 1983." Fruehauf, however, failed to disclose in its registration statement that in order to report positive income from operations in the first quarter of 1991, it reversed or released $6.9 million of excess reserves into first quarter income. Of the total $6.9 million in adjustments, $4.1 million related to purchase accounting reserves and $2.8 million was from inventory- related reserves. In addition to the $6.9 million in excess reserves released into income, purchase accounting reserves absorbed an additional $2.5 million in operating costs. Similarly, in the second quarter of 1991, Fruehauf reported income from operations of $6.4 million. Without the benefit of purchase accounting adjustments, however, Fruehauf had a loss from operations of $8.5 million, for a difference of $14.9 million. In its 1991 second quarter Form 10-Q, Fruehauf reported that for the three months ended June 30, 1991, "income from operations increased 24%" to $6.4 million versus $5.2 million for the same period in 1990, and that net income for the three month period was $1.9 million in 1991 versus $179,000 in 1990. However, Fruehauf, Skaff and Liechty, among others, failed to disclose that Fruehauf's earnings were achieved largely through a material $10 million nonrecurring adjustment related to the pension liability reversal discussed above. In fact, this adjustment was spread across several line items of the income statement. Despite their insistence that the amount of the pension accrual be disclosed, Skaff and Liechty, among others, caused Fruehauf to file its 1991 second quarter Form 10-Q, on August 15, 1991, with the following inadequate disclosure: During the second quarter of 1991, the Company recorded a nonrecurring adjustment to pension expense as a result of a change in certain pension benefits. This adjustment increased gross profit and income from operations for the three and six month periods ended June 30, 1991, increased net income for the three month period ended June 30, 1991 and reduced the net loss for the six month period ended June 30, 1991. The above disclosure contains no quantification of the adjustment nor explanatory footnote relating to the pension adjustment's impact on income.[10] In addition to the $10 million pension adjustment, Fruehauf released an additional $3.4 million of "excess" reserves into income and purchase accounting reserves absorbed an additional $1.5 million in operating costs, all without proper disclosure. In the third quarter of 1991, Fruehauf reported income from operations of $2.5 million. Without the benefits of purchase accounting, however, Fruehauf had a loss from operations of $7.8 million, for a difference of $10.3 million. Fruehauf's third quarter 1991 Form 10-Q failed to make any reference to the significant effect of purchase accounting on income from operations. Further, in its third quarter 1991 Form 10-Q, and amendments thereto, there was no reclassification of approximately $82.7 million of debt from a long-term to short- term liability as a result of Fruehauf's debt covenant violations.[11] For the fiscal year ended December 31, 1991, Fruehauf reported an operating loss of $23.2 million.[12] Purchase accounting adjustments for the year, however, totalled at least $22.3 million meaning that without the benefits of purchase accounting adjustments, Terex would have almost doubled its reported losses from operations to $45.4 million. Once again, Fruehauf's 1991 Form 10-K failed to disclose the nature and amount of these adjustments and failed to disclose the impact of these adjustments on current and future earnings. **FOOTNOTES** [6]: In its 1991 first quarter, Fruehauf charged $500,000 in salary and fringe benefits expenses of certain non-Westerville employees terminated in late March 1991 to the Westerville Reserve. Since these employees provided services related to Fruehauf's ongoing activities during Fruehauf's 1991 first quarter, the salary and fringe benefits expenses for these employees should have been expensed as period costs. [7]: Fruehauf improperly relied upon FAS No. 38, "Accounting for Preacquisition Contingencies of Purchased Enterprises," which requires adjustments made after the "allocation period" to be reflected in net income in the period adjusted. [8]: Due to Terex's ownership interest in Fruehauf, Terex's third quarter 1991 Form 10-Q, signed by Skaff, also failed to comply with GAAP in that Terex's current liabilities were understated due to Fruehauf's misclassification of the $82.7 million as long-term debt. [9]: The failure to disclose described in this section materially impacted Terex's public filings for 1990 through 1992 via consolidation; Fruehauf's IPO prospectus dated June 28, 1991; and Fruehauf's subsequent 1991 and 1992 public filings. These failures also impact both companies' filings through the 1995 restatement as managements' narrative continued to compare earlier misstated results to later years' results. [10]: Fruehauf amended its second quarter 1991 Form 10-Q, on November 15, 1991, to reflect the proper accounting for the $10 million pension liability reversal and its amortization over future periods. [11]: There was also no equivalent information contained in the second and third quarter Forms 10-Q, such as an explanatory footnote, which would alert the user of the financial statements that Fruehauf's lenders could accelerate the loans due to the company's failure to meet financial ratios. [12]: This figure includes a restructuring charge of $15.8 million without which Fruehauf would have shown an operating loss of $7.4 million. B. VIOLATIONS Skaff and Liechty, among others, Caused Fruehauf to Violate Certain Reporting and Recordkeeping Provisions of the Federal Securities Laws Section 13(a) of the Exchange Act requires issuers of securities registered pursuant to Section 12 of the Exchange Act to file with the Commission such periodic reports as the Commission shall prescribe by its rules and regulations. Rules 13a-1 and 13a-13 require issuers to file annual and quarterly reports, respectively. These filing requirements also include an obligation to set forth the information accurately. Pursuant to Section 4-01(a)(1) of Regulation S-X, the financial statements included in an issuer's periodic reports must be prepared in conformity with GAAP. No showing of scienter is required for establishing violations of Section 13(a) of the Exchange Act. Rule 12b-20 requires that periodic reports contain such further information as is necessary to make the required statements, in light of the circumstances under which they are made, not misleading. By incorrectly applying the purchase accounting guidance, Skaff and Liechty, among others, caused Fruehauf and Terex to file quarterly and annual reports which were not in conformity with GAAP because income was overstated before taxes by approximately $77.3 million from 1989 through 1992. Skaff and Liechty, among others, caused Fruehauf and Terex to file quarterly reports which were not in conformity with GAAP with respect to the release of a $10 million pension liability into income and the classification of a short-term liability as long- term debt. Additionally, Skaff and Liechty, among others, caused Fruehauf and Terex to file annual and quarterly reports which failed to disclose the impact of purchase accounting in MD&A on the quality of current and future income. Fruehauf also failed to quantify the amount of the pension released into income in its second quarter 1991 quarterly report and inadequately disclosed the details of the $1.6 million of Fruehauf’s funds in its 1992 annual report. Skaff and Liechty, among others, were a cause of Fruehauf's and Terex's violations of Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13 and 12b-20 thereunder by failing to accurately reflect, in addition to information expressly required to be included in such statements and reports, such further material information as was necessary to make the required statements, in light of the circumstances under which they were made, not misleading. Section 13(b)(2)(A) of the Exchange Act requires an issuer to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect its transactions. Skaff and Liechty, among others, were a cause of Fruehauf's and Terex's violations of Section 13(b)(2)(A) because its books, records and accounts overstated its earnings as a result of its purchase accounting practices, pension liability reversal and misclassification of its bank debt from fiscal 1989 through 1992. IV Based on the foregoing, the Commission finds that: Larry L. Skaff and John F. Liechty were a cause of Fruehauf's and Terex's violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a- 13 thereunder. V Accordingly, the Commission hereby orders, pursuant to Section 21C of the Exchange Act that: John F. Liechty and Larry L. Skaff cease and desist from causing any violation and any future violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary