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UNITED STATES OF AMERICA
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In the Matter of: KEITH M. ROBERTS, Respondent. |
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ORDER INSTITUTING PUBLIC CEASE-AND-DESIST PROCEEDINGS PURSUANT TO SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934 |
The Securities and Exchange Commission ("Commission") deems it appropriate that public cease-and-desist proceedings be and hereby are instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Keith M. Roberts ("Roberts" or "Respondent").
After an investigation, the Division of Enforcement alleges that:
1. This matter involves Roberts' role in artificially inflating the revenue of QuadraMed Corporation ("QuadraMed"), a publicly traded health care technology company, during Roberts' tenure as the company's Chief Financial Officer and General Counsel. During September 1998 and March 1999, Roberts had QuadraMed recognize revenue on two $5 million software licensing transactions that he negotiated with Health+Cast LLC ("Healthcast"), a small start-up software development company. In the September 1998 transaction, Roberts caused QuadraMed to guarantee a $12.5 million line of credit for the customer, which Healthcast then used to purchase a $5 million software license from QuadraMed. In the March 1999 transaction, Roberts caused QuadraMed to wire $5 million to Healthcast to finance an additional software purchase from QuadraMed. In both instances, Healthcast lacked the financial resources to pay QuadraMed for the software licenses and was not currently in a position to use or resell the QuadraMed software. Healthcast therefore purchased the QuadraMed licenses because it was functioning as a development arm for QuadraMed and because QuadraMed was providing Healthcast with the cash necessary to buy QuadraMed's software from QuadraMed. Additionally, Roberts withheld important information about these transactions from QuadraMed's outside auditors.
2.QuadraMed's recognition of revenue from the transactions violated Generally Accepted Accounting Principles ("GAAP") because collectibility for the transactions was not probable absent financial assistance from QuadraMed,1 and because there was no proper valuation of the licenses and services that were exchanged between QuadraMed and Healthcast. QuadraMed's improper reporting of revenue for these transactions rendered its press releases and its filings with the Commission materially misleading. Furthermore, QuadraMed failed to disclose the full extent of its relationship and agreements with Healthcast in its public filings and thereby hid from investors the questionably non-arm's-length character of the revenue from these two licensing "sales."
3. Roberts, age 39, resides in San Francisco, California. From 1997 to 2000, Roberts was QuadraMed's Vice President and General Counsel. From July 1998 to April 1999, Roberts also served as QuadraMed's Chief Financial Officer. Roberts is presently the Executive Vice President, General Counsel and Chief Financial Officer of a private company located in Santa Clara, California.
4. QuadraMed is a Delaware corporation. During the relevant period, the company was headquartered in San Rafael, California, but has subsequently relocated to Reston, Virginia. QuadraMed sells information technology and consulting services to hospitals and healthcare professionals, and licenses software products. QuadraMed's common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act. QuadraMed was delisted from the Nasdaq stock market in March 2003, and is currently quoted on the OTC bulletin board.
5. In July 1998, Roberts met with a small, privately-owned health care company (the "customer"). That customer was developing a computer interface that would allow hospitals and doctors to access a variety of medical software programs. QuadraMed wanted to have Healthcast incorporate QuadraMed's software into the interface. Initially, QuadraMed offered to provide Healthcast with a $2 million equity investment and a guarantee for a $4 million line of credit for a total cash infusion of $6 million, if Healthcast would integrate QuadraMed's product into the software interface. Healthcast elected, however, not to provide QuadraMed with an equity stake.
6. Eventually, on September 29-30, 1998, QuadraMed and its customer entered into a series of related transactions - that was negotiated by Roberts - in which QuadraMed arranged bank financing for Healthcast so that Healthcast had $6 million in working capital for development work on the customer interface and another $5 million to pay the licensing fee to QuadraMed. QuadraMed and its customer simultaneously executed an Investment Agreement, Credit Agreement, Note, Guarantee, Security Agreement, Registration Rights Agreement, Warrant Purchase Agreement, Non-exclusive Reseller Agreement, Escrow Agreement, License Agreement, Non-exclusive Software Agreement and a Development Agreement whereby Healthcast was to become a development unit for QuadraMed. Under the terms of the License Agreement, Healthcast agreed to purchase a nonexclusive license of source code from QuadraMed for $5 million. Under the terms of the Credit Agreement and Guarantee, QuadraMed guaranteed a $12.5 million line of credit for Healthcast, under which the bank would advance revolving loans "for the acquisition of technology rights and in the development of its business and for the purchase of capital equipment and working capital purposes," i.e., for purchasing the $5 million license from QuadraMed. Additionally, under the credit agreement, $1.5 million was set aside to cover interest. Thus, when the $1.5 million interest reserve and the $5 million licensing fee are deducted from the $12.5 million Guarantee, QuadraMed essentially provided Healthcast with the very same $6 million cash infusion that had been discussed for the equity proposal.
7. QuadraMed's guarantee was supposedly secured by a lien on all of Healthcast's assets. However, Healthcast's financial records for the period ended July 31, 1998, indicate that the company had less than $2 million in total assets, no revenue, and an operating loss of $2 million. Hence, Healthcast was not creditworthy because it had no financial ability to pay for QuadraMed's software absent QuadraMed's guarantee of the line of credit. Healthcast drew down from the line of credit in order to pay QuadraMed for the software license. Additionally, neither Healthcast nor QuadraMed made a reasonable determination of the fair market value of the software license.
8. QuadraMed typically offered customers 30-day payment terms. In this instance, however, Roberts structured the transaction so that Healthcast was required to make payment before September 30 (the last day of QuadraMed's third fiscal quarter). The obvious purpose of this requirement was to return $5 million of the bank's financing back to QuadraMed and to prevent others in QuadraMed or its outside auditors from reviewing Healthcast's creditworthiness.
9. Roberts authorized QuadraMed's Controller to recognize $4 million in revenue on the sale of the software license to Healthcast in QuadraMed's books and records for the quarter ended September 30, 1998.2 That revenue failed, however, to comply with GAAP due to Healthcast's reliance on the line of credit guaranteed by QuadraMed to pay for the transaction. On November 16, 1998, QuadraMed filed its Form 10-Q for the third quarter, after previously issuing a press release detailing its financial results. Roberts signed the Form 10-Q as the company's Chief Financial Officer. The 10-Q reported total revenue of $43.8 million and net loss of $2.2 million for the quarter. The improper recognition of revenue from the transaction caused QuadraMed's reported revenue to be overstated by about 10% and its reported net loss to be understated by about 218%.
10. A footnote to QuadraMed's Form 10-Q read as follows:
In September 1998, the Company entered into an arrangement to guarantee a line of credit of another company for up to $12,500,000. Outstanding balances under the line of credit accrue interest at 8.5% and are due October 1, 2001. The Company has also entered into a reseller agreement with the same company. Under the terms of the reseller agreement, the Company has a non-exclusive license to resell the company's software. This reseller agreement remains in effect for an initial term of three (3) years, expiring on September 29, 2001, and thereafter is subject to renewal for additional one-year terms.
That footnote involved a material omission because it failed to disclose that the guarantee was made for a customer who was using funds from the line of credit to purchase software from QuadraMed. It also failed to disclose that QuadraMed was booking revenue from a "customer" in which it had essentially become an investor through the Investment Agreement and related documents.
11. On March 31, 1999, QuadraMed filed its Form 10-K for the fiscal year ended December 31, 1998. Roberts signed the Form 10-K as the company's Chief Financial Officer and General Counsel. The 10-K reported total annual revenue of $159.4 million and a net loss from operations of $14 million. As a result of the improper reciprocal transaction, revenue for the fiscal year was overstated by 2.6% and the company's net loss was understated by 14.6%. As in the Form 10-Q, the Form 10-K mentioned the $12.5 million line of credit guarantee with a "reseller," but omitted any reference to the use of the credit line to pay QuadraMed for the $5 million license and to the relationship between QuadraMed and Healthcast.
12. Previously, in August 1998, QuadraMed's independent auditors had advised Roberts that QuadraMed could not record revenue from a hypothetical sale in which QuadraMed guaranteed a line of credit for Healthcast unless the guarantee was secured by assets that could be converted to cash. Despite that advice, Roberts failed to review Healthcast's financials.
13. QuadraMed's independent auditors reviewed the company's revenue recognition decisions shortly after the end of each fiscal quarter. At the time the auditors reviewed the transaction in early October 1998, Roberts did not advise the auditors or QuadraMed's Controller that QuadraMed had guaranteed a line of credit and that Healthcast was the borrower on the line of credit. Roberts also failed to advise the auditors and the Controller that Healthcast did not have any marketable assets sufficient to collateralize QuadraMed's security interest, and failed to provide them with copies of the Investment and Development agreements. As a result - and because the payment was not outstanding at the end of the quarter - the independent auditors and the Controller did not analyze the creditworthiness of Healthcast in order to determine whether collectibility was probable for the licensing transaction. Had the auditors reviewed the transaction, they could have seen that Healthcast had no means to pay for the purchase outside of the line of credit guaranteed by QuadraMed, and thus that revenue recognition was improper.
14. Roberts knew or should have known that his failure to inform the Controller and independent auditors about the guarantee and the lack of collateral would cause the sale to be recorded improperly on QuadraMed's books and records, and would cause material misrepresentations in the company's Form 10-Q for the quarter ended September 30, 1998 and the year ended December 31, 1998.
15. In February 1999, Healthcast's CEO contacted Roberts to ask for more money. Roberts and Healthcast's CEO then negotiated another reciprocal transaction in March 1999. Healthcast acquired a $5 million source code license for a suite of software products from QuadraMed. In return, QuadraMed agreed to prepay non-refundable licensing royalties of $5 million, and to pay Healthcast $6 million for a software license and source code for another software program.
16. By the time of the second transaction, Healthcast had exhausted the line of credit guaranteed by QuadraMed. Healthcast thus lacked sufficient funds to make the $5 million payment to QuadraMed. Roberts arranged for QuadraMed to wire funds to Healthcast that would be used to cover the $5 million payment. In late March 1999, Healthcast sent QuadraMed a $5 million check. Healthcast's CEO also sent a letter to Roberts, which stated:
In anticipation of funding the transaction contemplated by the Memorandum of Understanding, we are forwarding to you our company check in the amount of $5,000,000. We are providing this with the understanding that you will not present the check for collection at any bank or financial institution until such time as your company wires to us the total sum of $11,000,000 in completion of the various cash transactions agreed upon.
17. As with the September 1998 transaction, the transactions were structured so that QuadraMed would receive Healthcast's payment by the end of the fiscal quarter. As a result, there were no outstanding payments due at the end of the quarter, and the transaction escaped scrutiny by QuadraMed's outside auditors.
18. On May 17, 1999, QuadraMed filed its Form 10-Q for the quarter ended March 31, 1999, after issuing a press release detailing the quarterly results. The Form 10Q was signed by Roberts as the General Counsel. The Form 10-Q reported revenue of $59.6 million and a net loss of $25.6 million. As a result of the improper reciprocal transaction, QuadraMed's reported revenue was overstated by about 9% and its reported net loss from operations was understated by about 12%.
19. QuadraMed's Form 10-Q was also deficient because it failed to disclose the related-party character of the transactions with Healthcast and that QuadraMed had provided funds to Healthcast to purchase software from QuadraMed.
20. On March 29, 2000, QuadraMed filed its Form 10-K for the fiscal year ended December 31, 1999. Roberts reviewed a draft Form 10-K but did not sign the filing. The 10-K reported revenue of $240 million and a net loss from operations of $9.3 million. Because revenue from the $5 million March 1999 transaction should not have been recognized, QuadraMed's reported revenue for the fiscal year was overstated by about 2% and its reported net loss was understated by about 23%. As in the Form 10-Q, the Form 10-K omitted any reference to the related-party character of the transactions with Healthcast.
21. Roberts authorized QuadraMed's Controller to improperly recognize $5 million in revenue on the licensing contract with Healthcast in its books and records. The transaction failed to comply with the requirements for recognition under GAAP because Healthcast did not have an independent ability to pay for the transaction until it received funds from QuadraMed, and because there was no reliable and/or independent valuation of the consideration being exchanged in this reciprocal transaction. Furthermore, there was apparently little or no real value to QuadraMed from the transaction because, among other reasons, there was no forecasted use for Healthcast's product. QuadraMed also recorded the pre-paid royalties as an asset in its books and records, in violation of GAAP.3
22. Roberts did not show the March 31 letter from Healthcast's CEO to QuadraMed's independent auditors or Controller, or otherwise advise them of Healthcast's financial situation. Roberts also failed to advise the auditors that QuadraMed had wired $11 million to Healthcast prior to cashing Healthcast's check. As a result - and because the payment was not outstanding at the end of the quarter - the auditors and the Controller did not analyze the creditworthiness of Healthcast in order to determine whether collectibility was probable for the licensing transaction. Had the auditors reviewed the transaction during the quarterly review process, they could have seen that Healthcast had no means to pay for the purchase outside of the money that was wired from QuadraMed, and thus that revenue recognition was improper.
23. Roberts knew or should have known that his failure to inform the Controller and independent auditors about Healthcast's letter and the related nature of all the transactions with Healthcast would cause the sale to be recorded improperly on QuadraMed's books and records, and would cause material misrepresentations in the company's Form 10-Q for the quarter ended March 31, 1999 and the year ended December 31, 1999.
24. On June 6, 2003, QuadraMed filed restated financial statements for the fiscal years ended December 31, 1999, December 31, 2000 and December 31, 2001. In its restated financial statements, QuadraMed reversed the revenue from the March 1999 transaction. The financial statements for the year ended December 31, 1998 were not restated.
25. As a result of the conduct described above, QuadraMed engaged in fraudulent conduct in connection with the purchase or sale of securities by reporting false and misleading financial results in various Commission filings and public statements. QuadraMed also failed to file with the Commission accurate and complete reports, and filed reports that failed to include material information necessary to make its statements not misleading for the periods ended September 30, 1998, December 31, 1998, March 31, 1999 and December 31, 1999. In addition, QuadraMed failed to maintain books, records and accounts that, in reasonable detail, accurately and fairly reflected its transactions and dispositions of assets, and failed to maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions were recorded as necessary to permit the preparation of financial statements in conformity with GAAP.
26. Based on the foregoing, Roberts caused QuadraMed's violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder, which require all issuers whose securities are registered with the Commission pursuant to Section 12 of the Exchange Act to file with the Commission annual and quarterly reports containing such information as the Commission shall prescribe by its rules and regulations.
27. Based on the foregoing, Roberts caused QuadraMed's violations of Rule 12b-20, which requires that the annual and periodic reports filed pursuant to Rules 13a-1 and 13a-13 contain any additional information necessary to ensure that the required statements in the reports are not, under the circumstances, materially misleading.
28. Based on the foregoing, Roberts caused QuadraMed's violations of Section 13(b)(2)(A) of the Exchange Act, which requires issuers to make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions of the issuer.
29. Based on the foregoing, Roberts violated Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2, which prohibit a person from knowingly circumventing or knowingly failing to implement an issuer's system of internal accounting controls, knowingly falsifying an issuer's books, records or accounts, and making or causing to be made materially false or misleading statements, or omitting to state, or causing another person to omit to state, any material fact necessary in order to make statements made, in light of the circumstances under which such statements were made, not misleading to accountants in connection with any audit or examination of the financial statements of the issuer required to be made, or the preparation or filing of any document or report required to be filed with the Commission.
In view of the allegations made by the Division of Enforcement, the Commission deems it necessary and appropriate in the public interest that cease-and-desist proceedings be instituted to determine:
A. Whether the allegations set forth in Section II are true and, in connection therewith, to afford Respondent an opportunity to establish any defenses to such allegations; and
B. Whether, pursuant to Section 21C of the Exchange Act, Respondent should be ordered to cease and desist from causing violations and any future violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder, and from committing or causing violations and any future violations of Section 13(b)(5) of the Exchange Act and Rules 13b2-1 and 13b2-2 thereunder.
IT IS ORDERED that a public hearing for the purpose of taking evidence on the questions set forth in Section III hereof shall be convened not earlier than 30 days and not later than 60 days from service of this Order at a time and place to be fixed, and before an Administrative Law Judge to be designated by further order as provided by Rule 200 of the Commission's Rules of Practice, 17 C.F.R. § 201.200.
IT IS FURTHER ORDERED that Respondent shall file an Answer to the allegations contained in this Order within twenty (20) days after service of this Order, as provided by Rule 220 of the Commission's Rules of Practice, 17 C.F.R. § 201.220.
If Respondent fails to file the directed answer, or fails to appear at a hearing after being duly notified, the Respondent may be deemed in default and the proceedings may be determined against him upon consideration of this Order, the allegations of which may be deemed to be true as provided by Rules 155(a), 220(f), 221(f) and 310 of the Commission's Rules of Practice, 17 C.F.R. §§ 201.155(a), 201.220(f), 201.221(f) and 201.310.
This Order shall be served forthwith upon Respondent personally or by certified mail.
IT IS FURTHER ORDERED that the Administrative Law Judge shall issue an initial decision no later than 300 days from the date of service of this Order, pursuant to Rule 360(a)(2) of the Commission's Rules of Practice.
In the absence of an appropriate waiver, no officer or employee of the Commission engaged in the performance of investigative or prosecuting functions in this or any factually related proceeding will be permitted to participate or advise in the decision of this matter, except as witness or counsel in proceedings held pursuant to notice. Since this proceeding is not "rule making" within the meaning of Section 551 of the Administrative Procedure Act, it is not deemed subject to the provisions of Section 553 delaying the effective date of any final Commission action.
By the Commission.
Jonathan G. Katz
Secretary
1 Financial statements incorporated in Commission filings must comply with SEC Regulation S-X, which in turn requires conformity with GAAP. Statement of Financial Accounting Concepts No. 5 ("FASB CON 5") para. 83a defines revenues as "realized when products, merchandise or other assets are exchanged for cash or claims to cash." In essence, QuadraMed paid itself, so it did not receive cash inflows or claims to cash from its operations. Statement of Position 97-2, "Software Revenue Recognition," provides that revenue can be recognized from the sale of software only when all of the following criteria are satisfied: persuasive evidence of an arrangement exists; delivery has occurred; the vendor's fee is fixed or determinable; and collectibility is probable. SOP 97-2, para. 08.
2 The remaining $1 million was recorded as deferred revenue purportedly to insure against problems with source code delivery.
3 FASB CON 6 defines assets as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." The prepaid royalties were falsely recorded as an asset because the probable future benefits were speculative and the prepaid royalties to the customer were nonrefundable.
http://www.sec.gov/litigation/admin/34-49641-o.htm
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