UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 36560 / December 7, 1995 ADMINISTRATIVE PROCEEDING File No. 3-8891 _______________________________ : In the Matter of : ORDER INSTITUTING PUBLIC : ADMINISTRATIVE PROCEEDINGS, : MAKING FINDINGS AND IMPOSING UROHEALTH SYSTEMS, INC., : SANCTIONS formerly known as : Davstar Industries, Ltd., : : Respondent. : _______________________________: I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and they hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Urohealth Systems, Inc., formerly known as Davstar Industries, Ltd. (hereinafter "Davstar") violated or caused violations of Sections 10(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20 and 13a-1 thereunder. II. In anticipation of the institution of these administrative proceedings, the Respondent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, the Respondent consents to the issuance of this Order Instituting Public Administrative Proceedings, Making Findings and Imposing Sanctions ("Order"), without admitting or denying the findings set forth herein, and to the entry of this Order and imposition of the sanctions set forth below. III. On the basis of this Order and the Offer, the Commission makes the following findings 1: A. Respondent During all relevant times, Davstar was a Canadian corporation doing business in the U.S. from headquarters in Costa Mesa, California. Davstar subsequently changed its name to Urohealth Systems Inc. and reincorporated under the laws of the State of Delaware. Respondent's common stock has at all relevant times been registered with the Commission pursuant to Section 13 of the Exchange Act, and is listed for trading on the NASDAQ system. (Urohealth is hereinafter referred to as "Davstar"). Since its inception, Davstar has been engaged in the research, development and marketing of several proprietary medical products and laboratory devices, including three in particular: the "Cen-Slide," a combination test-tube and microscope slide for use in urinalysis; the "Dristar," a urinary incontinence product; and the "Lur-Lache," a plastic locking mechanism for intravenous equipment. Davstar's first sales of the Cen-Slide were in or about September 1992. In response to problems reported by initial product users and distributors, Davstar redesigned the Cen-Slide. Although the company continues to develop them, neither the Dristar nor the Lur-Lache was commercially available in the U.S. prior to September 1994. B. Davstar's False and Misleading Statements In or about May 1991, Davstar hired a "consultant," who proceeded to draft a number of press releases and other public statements purporting to describe the success of Davstar's product development, marketing and sales efforts, as well as the company's financial prospects and potential profitability. Davstar thereafter issued several press releases and other public statements which were materially false and misleading. 1. The June 18, 1991 Press Release In or about May 1991, Davstar approached ABCO Dealers, a medical products buying cooperative, about the possibility of offering the Cen-Slide to its clientele network. Davstar made a presentation to ABCO representatives, but received no binding commitment from ABCO to undertake any distribution efforts on Davstar's behalf. In the course of their discussions, ABCO acknowledged Davstar's application in a letter thanking Davstar for making its presentation. On or about June 18, 1991, Davstar issued a press release, entitled "Davstar Industries Receives Letter of Intent from ABCO Dealers" which materially misstated the nature and extent of the company's discussions with ABCO. In its press release, Davstar stated that it had received a "letter of intent" from a national clearing house of medical products to distribute the Cen-Slide and related Davstar proprietary equipment to its physician clientele network. According to the release, distribution of the Cen-Slide would commence on or about October 1, 1991. This press release was false in that Davstar had received no "letter of intent" or other undertaking to distribute the Cen-Slide or any other Davstar product. Instead, Davstar mischaracterized an acknowledgement letter from ABCO as a "letter of intent," thereby misrepresenting the true state of the Cen-Slide's marketability and the extent of market demand for the product. 2. Davstar's September 24, 1992 Press Release Some fifteen months later, Davstar issued another press release which similarly mischaracterized the nature and extent of its discussions with a federal government agency concerning the potential market for the Cen-Slide. On or about September 24, 1992, Davstar issued a press release, entitled "General Services Administration (GSA) Approves Cen-Slide System for Federal Government Purchase in $30 Million Annual Market." This release stated that the Cen-Slide had been "approved" by an agency of the federal government for distribution to government-related hospitals and facilities. Specifically, the release stated that: "the U.S. General Services Administration (GSA) had approved Davstar's closed-loop urinalysis system for purchase by Federal Government-related hospitals, medical facilities and agencies, including the Veterans Administration ... GSA has already issued government procurement identifiers 6640-3 and 6640-25 under Code B for the Cen-Slide System which should within weeks be added to the computer-listed GSA supply schedule." This release was false and misleading because, in fact, the GSA had never "approved" the Cen-Slide for current or future purchase by anyone. The actual effect of the GSA action was to identify Davstar as one of a number of potential suppliers of a certain type of medical or laboratory device, without lending any government sanction to the product or its manufacturer. Davstar's use of the term "approved" in this release at least implied that the government had evaluated the Cen-Slide and extended its imprimatur thereto while, in fact, GSA had only accepted product information submitted by the manufacturer and assigned the applicable procurement identifiers to reflect the category of the product. 3. The September 25, 1992 Press Release On September 25, 1992, in anticipation of filing its 1992 Annual Report on Form 10-K, Davstar issued another press release, entitled "Davstar Forecasts Profitability in Fiscal 1993 and Announces Results for Fiscal 1992." In that release, Davstar attempted to minimize the likely adverse impact on the trading price of its stock of the operating loss to be disclosed in its Form 10-K. While the company noted in this release that its loss for fiscal year 1992 had more than doubled to $0.34 per share from $0.15 per share for fiscal 1991, Davstar added that it "anticipates that its operations will turn profitable during its fiscal year ending June 30, 1993." The release went on to state that "with the recent commercial introduction of its revolutionary Cen-Slide closed-loop urinalysis system, and with the anticipated commercial introduction of its DriStar urinary incontinence system during fiscal year 1993, Davstar's operations are expected to turn profitable in fiscal 1993." Davstar had no reasonable basis to project that its operations would turn profitable in fiscal 1993. At the time of this release, Davstar had sold very few Cen-Slides and no Dristars. Furthermore, Davstar had reported a $2.8 million loss for 1992, and it had neither the market demand for its products nor the manufacturing capability to turn profitable at any time during 1993. Nor had the company done any reliable test marketing or other research on potential market demand for its products. 4. Davstar's 1992 Annual Report on Form 10-K On or about September 28, 1992, Davstar filed its Annual Report for its 1992 fiscal year on Form 10-K with the Commission. The Form 10-K reiterated, falsely, that "[t]he United States [GSA] had approved the Cen-Slide and Cen-Slide 60 Centrifuge for purchase by federal government related hospitals, medical facilities and agencies, including the Veterans Administration." 5. The November 15, 1992 Press Release On or about November 14, 1992, a newspaper article criticized the accuracy of certain Davstar press releases, including the September 24, 1992, release discussed above. The next day, on November 15, 1992, Davstar issued a press release denouncing the article and reaffirming the company's prospects. In that release, Davstar stated that it had received "uniformly positive feedback" from the users and distributors of its Cen-Slide system. The company also reaffirmed the accuracy of its prior press releases. The November 15, 1992, release was materially false and misleading in that Davstar had not received "uniformly positive feedback" regarding the Cen-Slide. To the contrary, as of November 15, 1992, Davstar had received complaints concerning several different aspects of the Cen-Slide which led to Davstar's eventual redesign of the Cen-Slide. In March 1993, Davstar began marketing an entirely new version of the product. Davstar received other complaints which related, among other things, to the cost of the product and its incompatibility with standard microscopes. C. False and Misleading Public Statements Prepared and Disseminated on Davstar's Behalf In addition to press releases issued directly by the company, Davstar also enlisted the assistance of other persons who disseminated false and misleading publicity about the company and its prospects. Initially, Davstar retained a "consultant" and gave him free rein, among other things, to prepare drafts of the false press releases discussed above, and to recruit others to help the company raise money. Davstar was introduced to a widely-read stock market newsletter publisher and a registered representative in Phoenix, Arizona, both of whom subsequently disseminated false and misleading information about the company and its prospects. Beginning in May 1991 and continuing until at least November 1992, the newsletter publisher promoted Davstar as, among other things, his "Stock of the 90's." Throughout this time, two of his periodic publications repeatedly contained materially false and misleading statements concerning Davstar, its business prospects and potential earnings projections. These statements appeared in each publication at least once per month. For example, less than two months after being introduced to Davstar, this publisher projected that Davstar would have $12 million in sales revenues in its 1992 fiscal year and that Davstar "could easily" obtain a 20% share of the urinalysis market. In late 1991, he reported that Davstar was projecting 10% penetration of the U.S. market, which included for the Dristar all incontinent adults. These statements were false and made without any reasonable basis. Although these and similar false statements appeared from the text to be unbiased opinions of an independent newsletter publisher, in fact the company had compensated the publisher to disseminate such favorable publicity. In a May 1992 research report distributed to his retail clients, the Arizona registered representative enlisted to promote Davstar stock published projections based on information he received from the company. According to this report, Davstar would have earnings of $0.90 per share in 1993 and $1.93 in 1994. As of the date the report was issued, Davstar had never earned a profit, and the projections contained in the report had no reasonable basis. Davstar retained and compensated the newsletter publisher and the registered representative to publish favorable news and opinion about Davstar. In addition, company officials were aware that these persons were disseminating false and misleading information about the company, including inflated projections, to the public. Company officials nevertheless took no steps to correct or prevent dissemination of false and misleading information. IV. LEGAL DISCUSSION Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit the intentional or reckless dissemination of materially false and misleading statements and omissions in connection with the purchase and sale of a security. See Basic, Inc. v. Levinson, 485 U.S. 224, 231 (1988); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 860-62 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). A misrepresented or omitted fact is material if there is "a substantial likelihood that a reasonable investor would consider it important" in making investment decisions. Basic at 231; TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Section 13(a) of the Exchange Act and Rule 13a-1 thereunder require issuers whose securities are registered with the Commission pursuant to the Exchange Act to file annual reports. Such reports must be true and correct. See SEC v. Savoy Industries, 587 F.2d 1149 (D.C. Cir. 1978). Rule 12b-20 requires that such reports include all material information necessary to make the required statements, in the light of the circumstances under which they are made, not misleading. As set forth above, Davstar's statements contained in press releases were materially false and misleading in violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Davstar's statements in an Annual Report filed with the Commission were materially false and misleading in violation of Sections 10(b) and 13(a) of the Exchange Act, and Rules 10b-5, 12b-20 and 13a-1 thereunder. In addition, Davstar violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in connection with the materially false and misleading statements published by third parties on the company's behalf and with its approval and authorization. See Elkind v. Liggett & Myers, 635 F.2d 156, 163 (2d Cir. 1980). Davstar knew or had to have known that the statements it published, and those published by others on its behalf, were false and misleading. See Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569-70 (9th Cir. 1990), cert. denied, 499 U.S. 976 (1991). V. ORDER In view of the foregoing, it is in the public interest to impose the sanction specified in the Offer submitted by Respondent. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Respondent cease and desist from committing or causing any violation, and any future violation, of Sections 10(b) and 13(a) and Rules 10b-5, 12b-20 and 13a-1 thereunder. By the Commission. _____________________________ Jonathan G. Katz Secretary 1 The findings herein are made pursuant to the Respondent's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.