-1- UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 40279 / July 30, 1998 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 1056 / July 30, 1998 ADMINISTRATIVE PROCEEDING File No. 3-9659 ______________________________ : In the Matter of :ORDER INSTITUTING PUBLIC :PROCEEDING AND OPINION AND IVOR R. ELLUL and :ORDER PURSUANT TO SECTION JOSEPH R. SUMMA, :21C OF THE SECURITIES :EXCHANGE ACT OF 1934 Respondents : ______________________________: I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative proceeding be, and hereby is, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether Ivor R. Ellul and Joseph R. Summa caused violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and violated Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder. II. In anticipation of the institution of this proceeding, Ellul and Summa have submitted Offers of Settlement ("Offers"), which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the Commission's findings contained herein, except as to the Commission's finding of jurisdiction over them and the subject matter of this proceeding, Ellul and Summa consent to the issuance of this Order Instituting Proceedings ("Order") and to the entry of the findings and the imposition of the relief set forth below. -2- III. FACTS Based on the foregoing, the Commission finds[1] that: 1.Summary From 1993 through 1995, Scientific Software-Intercomp, Inc. ("SSI"), an engineering and software company in the oil and gas industry, and certain of its executive officers and employees engaged in a financial fraud that violated the anti-fraud, periodic reporting, books and records, and internal controls provisions of the federal securities laws.[2] From at least the third quarter of 1993 through the first quarter of 1995, SSI engaged in a fraudulent scheme to inflate revenues by recognizing premature and fictitious revenue. As a result, SSI's Forms 10-K and 10-Q filed with the Commission during this period were materially false and misleading. In addition, SSI sold approximately $8 million of common stock in an offering registered on a materially false and misleading Form S-1 in June 1994. SSI improperly recognized revenue from license agreements that were subject to cancellation or otherwise contingent as of period-end, from sales of products that were not delivered by period-end and from license agreements not executed by period- end. In the fourth quarter of 1993, SSI recognized at least $600,000 of improper revenue from unexecuted license agreements and agreements with contingencies that had not been removed by the close of the quarter. For the year ended December 31, 1994, SSI recognized in excess of $1.7 million in revenue from sales to value added resellers ("VAR"s) that were subject to side letters, excusing the VARs from any obligation to pay or allowing them to treat the contracts as ineffective until they had resold the software. 2.Respondents a.Ivor R. Ellul, age 38, was SSI's vice president of products for the company's Pipeline and Facilities Division from 1991 through December 1993, and from January 1994, until December 1994, he was Vice President of Pipeline and Facilities. b.Joseph R. Summa, age 46, was an SSI vice president and senior salesman for the company's Pipeline and Facilities Division until July 1994. 3.Issuer Scientific Software-Intercomp, Inc. is a Colorado corporation with executive offices in Denver, Colorado. SSI's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act and is listed on NASDAQ. As of June 26, 1997, 8,840,138 shares of SSI common stock were outstanding. 4.SSI's Pipeline and Facilities Division During the relevant period, SSI's Pipeline and Facilities Division ("P&F Division"), located in Houston, Texas, provided software and consulting services for major oil and gas companies, principally in the areas of oil field monitoring and simulation and leak detection. The P&F Division contributed approximately 26% of SSI's total revenues. Beginning in the early 1990's, the P&F Division began a marketing program using VARs to sell its software products. Under a VAR arrangement, SSI entered an agreement with the VAR to sell SSI's software, and the VAR would market the software. The agreement required that the VAR's purchase would be unconditional and the software shipped to the VAR would be fully usable by the VAR on delivery. SSI also provided consulting services to customers, including VAR's, pursuant to long term contracts. These services were principally on-site maintenance and upgrade services, sold in connection with larger software packages. 5.SSI's Improper Revenue Recognition Beginning in the fourth quarter of 1993 and continuing through the first quarter of 1995, SSI materially overstated its revenues generated by the P&F Division. The revenue overstatements were motivated by SSI's inability to meet revenue projections, which were publicly disseminated throughout this period to analysts and investors. Indeed, SSI had a history of predicting consecutive profitable quarters throughout this period. SSI improperly recognized revenue in a number of ways. First, SSI routinely executed license agreements with VARs with simultaneous side letters excusing payment or allowing for the VAR to treat the contract as ineffective until the VAR resold the software. Second, SSI routinely backdated contracts and shipping documentation so as to recognize revenue prematurely. Third, SSI recorded revenue before persuasive evidence of a contract existed. Fourth, SSI recorded revenue where product had not been delivered. Finally, SSI recorded revenues for work on long term projects that had not been completed, or was not even scheduled for completion in the quarter the revenue was recognized. These practices all violated generally accepted accounting principles ("GAAP"). a.Software i.Side Letters At the end of 1993, it became a common practice within the sales force in the P&F Division at SSI to give VARs "side letters" excusing payment or making the license agreement ineffective until the VAR sold SSI's product to an end user. Ellul and Summa were aware of the existence of side letters and their use by SSI to improperly book revenue. In the third and fourth quarters of 1993 and the first quarter of 1994, Summa gave several side letters to ABB, a VAR, that excused payment until ABB resold SSI's product to end users with whom contracts were pending. Despite the fact that ABB had not sold the product by year-end, and in at least one instance the contract was executed after year-end, the revenue on these contracts, amounting to more than $575,000, was booked in the second half of 1993. Summa gave a side letter to Valmet Automation, another VAR, that excused payment until Valmet completed a sale of SSI's product to another party. The full amount of this contract, $200,000, was booked in the first quarter of 1993 and remained on SSI's books throughout 1993 even though Valmet had not sold any of SSI's products by the end of 1993 and thus was not obligated to pay SSI under the contract as modified by the side letter. In the first quarter of 1994, SSI booked $500,000 for a contract it had with Envirotech Controls, Inc., a VAR to whom Ellul had given a side letter. At the time the revenue was booked, Envirotech had not made any sales of SSI's software as required by the side letter for the contract to commence, and thus Envirotech had no obligation to make payment to SSI under the contract. In all, in the third and fourth quarters of 1993 and throughout 1994, SSI booked revenue in excess of $2 million from contracts on which the P&F Division gave side letters either excusing payment or rendering the contract ineffective, contrary to GAAP. ii.Backdating During the period from 1993 through December 1994, Ellul and Summa backdated a significant number of the P&F Division's contracts by signing them "effective" as of the last day of the quarter, even though the actual contracts were executed and became binding after the quarter-end. These contracts were booked as revenue in the prior quarter contrary to GAAP. In addition to the backdating of contracts, throughout the same period, the P&F Division, with the knowledge of Summa, booked revenue from sales of software in quarters where software was shipped after the quarter-end, and backdated shipping documentation. b.Project Revenue Prior to and during the relevant period, SSI improperly recognized project revenue of the P&F Division in violation of GAAP. Many of the P&F Division's projects were long term service contracts requiring the expenditure of significant man-hours over the course of several months or even years. However, SSI recognized revenues for work that had not been performed. Ellul was aware of this practice while employed at SSI. 7.Ellul's Performance-Based Compensation During 1993, Ellul received SSI stock options which vested during 1993 and 1994. These stock options were exercised by Ellul after he left SSI in 1995 for total additional compensation of $20,187. **FOOTNOTES** [1]:The findings herein are made pursuant to the Offers of Settlement submitted by Ellul and Summa and are not binding on any other person or entity in this or any other proceeding. [2]:On September 11, 1997, the Commission filed a civil injunctive complaint in the United States District Court for the District of Columbia against SSI alleging violations of Section 17(a) of the Securities Act of 1933 and Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, 13a-11 and 13a-13 thereunder. Simultaneous with the filing of the complaint, SSI consented, without admitting or denying the allegations of the complaint, to injunctive relief and agreed to restate its financial statements for the years ending December 31, 1993, 1994 and 1995. See SEC v. Scientific Software- Intercomp, Inc., 97-CV-2091 (JGP) (D.D.C.), Litigation Release No. 15485 (September 11, 1997). -3- IV. OPINION 1.The Antifraud Provisions -- Section 10(b) of the Exchange Act and Rule 10b-5 thereunder Section 10(b) of the Exchange Act and Rule 10b-5 thereunder proscribe materially false and misleading statements "in connection with the purchase or sale of any security." Violations of Section 10(b) and Rule 10b-5 occur when an issuer makes material misstatements in periodic reports filed with the Commission, including financial statements, and trading thereafter occurs in the issuer's securities. SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The American Institute of Certified Public Accountants ("AICPA") issued Statement of Position on Software Revenue Recognition 91-1 ("SOP 91-1") on December 12, 1991, to provide guidance on applying GAAP to software license revenue. SOP 91-1 established that revenue from sales of software generally cannot be recognized until the software is delivered, collectibility is probable and the vendor has no significant obligations remaining under the sales arrangement. It also established the following rules: (1) for software licenses evidenced by a written contract signed by the vendor and the customer, revenue should not be recognized until persuasive evidence of the agreement exists; usually a signed contract provides such evidence; (2) revenue from cancelable licenses should not be recognized until the cancellation privileges lapse; and (3) if, after delivery, there is significant uncertainty about customer acceptance of the software, license revenues should not be recognized until the uncertainty becomes insignificant. Ellul and Summa, both officers of SSI's Pipeline and Facilities Division, caused SSI's violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Ellul and Summa executed side letters on contracts that they knew or should have known would be booked improperly, with the corresponding revenue reported to the public. Ellul and Summa also understood that revenue was properly recognized only when product was shipped and persuasive evidence of a contract existed. Despite this understanding, Summa closed sales after period-end for inclusion in the prior period, executing backdated documents to facilitate the practice. Ellul backdated contracts and knew that SSI improperly recognized project revenue on long-term contracts. -4- 2.The Books and Records Provisions -- Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder Section 13(b)(5) of the Exchange Act makes it unlawful for any person to knowingly circumvent internal accounting controls or knowingly falsify any book, record, or account of a publicly traded company. Rule 13b2-1 thereunder makes it unlawful for any person, directly or indirectly, to falsify or cause to be falsified, any book, record, or account of a reporting issuer. By engaging in the practices described above, Ellul and Summa knowingly circumvented accounting controls, in violation of Section 13(b)(5) of the Exchange Act. Moreover, by directly or indirectly causing to be falsified various books, records, or accounts, as described above, Ellul and Summa violated Rule 13b2- 1. V. Based on the foregoing, the Commission finds that Ellul and Summa caused violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and violated Section 13(b)(5) of the Exchange Act and Rule 13b2-1 thereunder. VI. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that: A.Ellul and Summa cease and desist from committing or causing any violation, and committing or causing any future violation, of Sections 10(b) and 13(b)(5) of the Exchange Act and Rules 10b-5 and 13b2-1 promulgated thereunder; and B.Ellul disgorge $20,187, plus prejudgment interest of $5,408. Payment of $25,595.00 shall be made within ten (10) days of the entry of the Order. Payment shall be made by U.S. postal money order, certified check, bank cashier's check, or bank money order, made payable to the "Securities and Exchange Commission" and bearing on its face the caption "In the Matter of Ivor R. Ellul"; and shall be transmitted by certified mail (return receipt requested) to the Comptroller, U.S. Securities and Exchange Commission, Mail Stop 0-3, 450 Fifth Street, N.W., Washington, D.C. 20549; under cover of a letter that identifies the respondent, the name of the matter and the Administrative Proceeding file number, and the Commission's case number (HO-3075). A copy of the cover letter and the check or money order shall be transmitted simultaneously to Gregory S. Bruch, Esq., at the -5- U.S. Securities and Exchange Commission, Mail Stop 7-3, 450 Fifth Street, N.W., Washington, D.C. 20549. By the Commission. Jonathan G. Katz Secretary