On Wednesday, The Securities and Exchange Commission filed a complaint in federal court in Los Angeles charging Gemstar-TV Guide International, Inc. with improperly reporting its highly touted interactive program guide licensing and advertising revenues in its financial statements from 1999 through 2002.
Gemstar agreed to settle the case by, among other things, paying a $10 million civil penalty. That money will be distributed to harmed shareholders pursuant to Section 308 of the Sarbanes-Oxley Act of 2002. In assessing the penalty amount, the Commission considered the scope and severity of Gemstar's misconduct, Gemstar's initial failure to cooperate in the Commission's investigation or undertake remedial actions, and Gemstar's significant cooperation and remediation following a change in senior management and restructuring of its corporate governance.
Gemstar is a Los Angeles-based media and technology company that is publicly traded on the Nasdaq Stock Market. Among its business activities, Gemstar publishes TV Guide magazine and develops, licenses, and markets an interactive program guide (IPG), which is a technology that enables consumers to navigate through and select television programs. During the relevant period, Gemstar generated revenues from the IPG by licensing the technology to third parties and selling advertising space on the IPG.
"The magnitude of the improper conduct at Gemstar, together with its initial lack of effective cooperation or remedial efforts, warrant the imposition of a significant monetary penalty," said Randall R. Lee, Director of the Commission's Pacific Regional Office. "At the same time, we have credited the company for its extensive cooperation once new management took control," Lee added. "We are continuing to pursue our case against former Gemstar senior management."
The Commission's complaint alleges that Gemstar materially overstated its revenues by nearly $250 million through the following means.
First, Gemstar recorded revenue under expired, disputed, or non-existent agreements, and improperly reported this as IPG licensing and advertising revenue.
Second, Gemstar recorded and reported revenue from a long-term agreement on an accelerated basis in contravention of GAAP and Gemstar's own stated and disclosed revenue recognition policy, which required the recording and reporting of such revenue ratably over the terms of the agreement.
Third, Gemstar inflated its IPG advertising revenue by improperly recording and reporting revenue amounts from multiple-element transactions. Gemstar's recording and reporting of this revenue was improper under GAAP because Gemstar could not determine the IPG advertising's fair value. Additionally, some of those improperly reported transactions included so-called "round-trip" transactions whereby Gemstar paid money to a third party that then used those funds to buy advertising from Gemstar. Gemstar also failed to disclose that it had structured certain settlements for the purpose of creating "cookie jars" of IPG advertising revenue.
Fourth, Gemstar improperly recorded and reported IPG advertising revenue from non-monetary and barter transactions. Gemstar's recording and reporting of this revenue was not in accordance with GAAP because it did not meet the revenue recognition requirements for such transactions and because Gemstar could not properly establish the IPG advertising's fair value.
Finally, Gemstar improperly reported certain revenues as IPG advertising revenues when in fact those revenues were derived from the sale of print advertising. Gemstar shifted revenues by invoicing advertisers for both IPG and print advertising, but recording the revenue only as IPG revenue.
The misstatements of revenue were reported in Forms 10-K, 10-Q, and 8-K filed with the Commission. These public statements misrepresented Gemstar's true financial performance and failed to disclose material information about that performance. The complaint further alleges that when Gemstar disclosed in its 2001 Form 10-K filed on April 1, 2002, that revenue from two transactions had been recorded under an expired licensing agreement and in a non-monetary transaction, Gemstar's stock price declined by approximately 37% the next day.
As part of its settlement, Gemstar, without admitting or denying the allegations in the Commission's complaint, agreed to a permanent injunction against future violations of the periodic reporting, recordkeeping, and internal controls provisions of the federal securities laws.
In determining to accept Gemstar's settlement offer, the Commission considered the following factors, among others, relating to the company's cooperation and remedial efforts:
- In April 2002, immediately after Gemstar filed its 2001 Form 10-K, the Commission contacted Gemstar and commenced an investigation. For nearly the next eight months, while Gemstar's former CEO and other senior officers remained in place, the company did not conduct a thorough or comprehensive internal investigation and did not take other appropriate remedial action, even when presented by the Commission with specific evidence of fraudulent conduct.
- As a result of its inadequate investigation, in August 2002 Gemstar issued a restatement reversing only approximately $20 million in revenue. Gemstar consequently continued to report overstated revenues to the investing public even after the Commission's investigation began.
- In November 2002, in connection with the restructuring of its corporate governance, Gemstar replaced its CEO, CFO, and general counsel and adopted extensive new internal controls. The company also retained a new independent auditor and a new independent outside counsel.
- Following the change in senior management, Gemstar (i) initiated a comprehensive investigation and re-audit of its financial statements; (ii) restated its financials three more times, reversing revenues by a total of $377 million; (iii) provided extensive and valuable assistance to the Commission in its investigation; and (iv) voluntarily agreed not to make certain extraordinary severance payments to its former CEO and CFO for over six months, among other things.