UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 41409 / May 17, 1999 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 1133 / May 17, 1999 ADMINISTRATIVE PROCEEDING File No. 3-9899 ----------------------------------------------------------------- ORDER INSTITUTING PUBLIC In the Matter of: CEASE-AND-DESIST PROCEEDING PURSUANT TO SECTION 21C OF INSIGNIA SOLUTIONS PLC, THE SECURITIES EXCHANGE ACT OF 1934, MAKING FINDINGS, AND Respondent. IMPOSING A CEASE-AND-DESIST ORDER ----------------------------------------------------------------- I. The Securities and Exchange Commission ("Commission") deems it appropriate that a public cease-and-desist proceeding be, and hereby is, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Insignia Solutions plc ("Insignia" or the "Company" or "Respondent") violated Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. II. In anticipation of the institution of this proceeding, Insignia has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that Respondent admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, Insignia consents to the issuance of this Order Instituting Public Cease- and-Desist Proceeding Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and- Desist Order ("Order") and to the entry of the findings and the imposition of the relief set forth below. III. On the basis of this Order and Respondent's Offer, the Commission finds the following: A. RESPONDENT Insignia Solutions plc is an English public limited corporation which does business in the United States through its wholly owned subsidiary, Insignia Solutions Inc., a Delaware corporation. Both the parent and the subsidiary have their headquarters and principal management, sales, marketing and support facilities in Fremont, California. The Company develops, markets and supports cross-platform compatibility software that enables users to run Windows and DOS applications on various desktops, including UNIX workstations and Macintosh computers. In November 1995, Insignia held its initial public offering ("IPO") in which it and certain selling shareholders offered 3.6 million American Depositary Shares ("ADS"), with each ADS representing one ordinary share of Insignia Solutions plc. The ADS’s are registered with the Commission pursuant to Section 12(g) of the Exchange Act and are quoted on NASDAQ. B. CONDUCT LEADING TO INSIGNIA’S MATERIALLY MISLEADING FORMS 10-Q FOR THE FIRST AND SECOND QUARTERS OF 1996 On February 27, 1997, the Company announced that it was restating its financial statements for the first and second quarters ended March 31, 1996 and June 30, 1996. It stated that the restatement was caused by irregularities in the reporting of sales contracts and reseller inventories by certain employees in its U.S. channel sales organization, the organization that handles sales through distributors. Following the announcement, the Company's shares closed at $2 17/32, down $1 11/32 from the prior day's closing price of $3 7/8 (a 35% decline). Trading volume of 623,400 shares was approximately 10 times higher than the prior ten-day average trading volume. For the first quarter ended March 31, 1996, the Company reported restated revenue of $13.1 million, compared to previously reported revenue of $14.7 million, or an overstatement of 12.2%, and a restated net loss of $225,000, compared to previously reported net income of $749,000, or an overstatement of 433%. The first quarter restatement was attributable to a fraudulent revenue recognition scheme orchestrated by a sales vice president who was also a member of Insignia’s executive staff, and implemented primarily by a sales manager who reported to the sales vice president (together, the "Supervisors"). The scheme began with the Supervisors arranging for a shipment of $1.2 million in software to one of Insignia’s resellers and concealing side letters that granted extremely liberal return rights. Then, to avoid having Insignia’s Finance Department recognize an allowance for the excess product held by the reseller, the Supervisors also instructed a subordinate to change the reseller’s inventory reports to Insignia to "drop the zero" from -- or report only 10% of -- the reseller’s inventory. In order to cover up the scheme, the Supervisors concealed a letter relating to a stock rotation of the product by the reseller, which under the circumstances should have been accounted for as a $400,000 return of goods sold. Insignia reported restated revenue for the second quarter ended June 30, 1996 of $14.9 million, compared with previously reported revenue of $15.7 million, or an overstatement of five percent, and restated net income of $569,000, compared with previously reported net income of $1.454 million, or an overstatement of 156 percent. The majority of the second quarter restatement was attributable to an overstatement of revenue relating to an order from a customer who had liberal return rights which were not properly accounted for in Insignia’s financial records due to an error by certain members of Insignia’s Finance Department. 1. Insignia Overstated Its Revenue and Net Income and Understated Its Allowance for Returns for the First Quarter of 1996 Insignia’s revenue recognition policy provided that revenue "[is] recognized upon shipment if no significant vendor obligations remain and if collection of the resulting receivables is deemed probable." Because Insignia generally permitted certain rights of return, it recognized allowances for estimated future returns and exchanges. Specifically, Insignia recognized an allowance for all inventory in excess of the estimated sell through in the next 45 days ("45 day reserve policy"). In effect, Insignia subtracted this allowance from its gross revenue to arrive at revenue. In order to implement this policy, Insignia endeavored to keep track of inventory held by its principal distributors and resellers. The fraudulent revenue recognition scheme involved the circumvention of this system for monitoring inventory in the hands of Insignia’s distributors and resellers. In late December 1995, the Insignia sales vice president instructed the sales manager to arrange for the shipment of approximately $1.2 million in software to a reseller. The sales manager, at the direction of the sales vice president, signed side letter agreements with a distributor and the reseller which allowed liberal return rights for the December shipment. After the shipment, the Supervisors instructed a subordinate to "drop the zero" or report only 10% of the inventory held by the reseller. By underreporting the inventory, the Supervisors made it appear that the reseller held only a fraction of the product, when, in fact, it held product greatly in excess of a 45-day supply. This had the effect of decreasing Insignia’s allowance for product returns, thereby increasing reported revenue. Insignia did not restate results for the fourth quarter of 1995 because its allowance for that quarter was sufficient to cover the additional unreported inventory resulting from the foregoing conduct. However, most of the goods involved in the "drop the zero" scheme remained unsold by the reseller at the end of the first quarter of 1996. Since Insignia’s allowance for that quarter was not otherwise sufficient to account for these goods, this conduct caused the Company to underreport its allowance for that reseller and overstate its revenue by $1.1 million in its quarterly report on Form 10-Q for the first quarter of 1996. Additional conduct related to the same reseller caused Insignia to overstate its revenue by an additional $400,000 for the first quarter of 1996. By early 1996, some of the software that Insignia had shipped to the reseller in December 1995 had become obsolete and the reseller wanted to exchange a large percentage of the software for updated versions. The sales vice president and his staff sent out updated software in March 1996 as part of this exchange, pursuant to a letter dated March 1, 1996, signed by a junior salesperson. In the letter, Insignia agreed to ship new product to the reseller in the first quarter of 1996 and the reseller agreed that it would return a portion of the December shipment in exchange for updated versions. The sales vice president and the sales manager did not provide the March 1996 letter to Insignia’s Finance Department. Had they done so, Insignia’s Finance Department could have been alerted to the fact that the March 1996 transaction was an exchange of goods, not a new sale. In addition, the Finance Department could have been alerted to the contradiction between the inventory reports previously submitted by the sales staff for that reseller and the amount of goods now being presented for exchange. Because Insignia accounted for the March 1996 transaction as a new sale, rather than as an exchange, Insignia overstated revenue in its first quarter 10-Q by an additional $400,000. 2. Insignia Overstated Its Revenue and Understated Its Net Loss and Allowance for Returns for the Second Quarter of 1996 Insignia did not appropriately reserve for a $750,000 shipment to a new distributor during the second quarter ended June 30, 1996, resulting in an overstatement of revenue. Insignia reported this overstated revenue in its 10-Q for the second quarter of 1996. The distributor was a new customer of Insignia, although they had been negotiating for a few months. On June 28, 1996, the last business day of the second quarter, the distributor submitted an initial stocking order for approximately $750,000 of Insignia software. Under the terms of its basic contract with Insignia, the distributor could return, with no time limitation, any product purchased within the first 60 days of their relationship. Insignia recognized the entire shipment as a sale for the second quarter at the time of shipment, and did not establish an appropriate allowance against sales until the following quarter. Insignia should have fully reserved against the sale in the second quarter, resulting in no reportable revenue, because Insignia gave the distributor open return rights. The overstatement was the result of an error by certain members of Insignia’s Finance Department. As part of the restatement, Insignia reduced second quarter revenue by $750,000. C. Legal Analysis: Insignia’s Violations Related to Its Periodic Reports and Books and Records, . Midisoft's Violations Related to Its Periodic Reports; Books and Records; and Internal Accounting Controls "Sections 13(a) and 13(b)(2)(A) and Rules 12b-20 and 13a-13 .Reporting Violations\: Section 13(a) and Rules 12b-20 and 13a-1 " Section 13(a) of the Exchange Act requires all issuers whose securities are registered with the Commission pursuant to Section 12 of the Exchange Act to file with the Commission periodic reports containing such information as the Commission shall prescribe by its rules and regulations. Pursuant to Section 13(a), the Commission has promulgated Rule 13a-13, which requires issuers to file with the Commission periodic reports and Rule 12b-20, which requires that such reports contain any additional information necessary to ensure that the required statements in the reports are not, under the circumstances, materially misleading. Courts have 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, 587 F.2d 1149, 1167 (D.C. Cir. 1978). Insignia violated Section 13(a) of the Exchange Act and Rules 13a-13 and 12b-20 by filing materially misleading financial statements in Forms 10-Q for the first and second quarters of fiscal year 1996. 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 of the issuer. Insignia violated Section 13(b)(2)(A) because its books, records and accounts did not accurately and fairly reflect revenue and related allowances. IV. On the basis of this Order and the Offer submitted by Respondent, the Commission finds that Insignia violated Sections 13(a) and 13(b)(2)(A) 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 Insignia cease and desist from committing or causing any violation and any future violation of Sections 13(a) and 13(b)(2)(A) of the Exchange Act, and Rules 12b-20 and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary