UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 37719 / September 24, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 821 / September 24, 1996 ADMINISTRATIVE PROCEEDING File No. 3-9095 ______________________________ : In the Matter of : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO SECTION 21C OF THE Wilshire Technologies, Inc. : SECURITIES EXCHANGE ACT OF 1934, : MAKING FINDINGS AND IMPOSING A Respondent. : CEASE-AND-DESIST ORDER ______________________________: I. The Securities and Exchange Commission (the "Commission") deems it appropriate that public administrative proceedings be instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Wilshire Technologies, Inc. ("Wilshire"). Accordingly, IT IS HEREBY ORDERED that said proceedings be, and hereby are, instituted. II. In anticipation of the institution of these administrative proceedings Wilshire has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purposes of these proceedings 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 herein, except that Wilshire admits the jurisdiction of the Commission over it and over the subject matter of these proceedings, Wilshire consents to the entry of this Order Instituting Proceedings 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 imposition of the sanctions as set forth below. ==========================================START OF PAGE 2====== III. FINDINGS On the basis of this Order and of the Offer of Settlement of Wilshire, the Commission makes the following findings:1/ A. The Respondent Wilshire Technologies, Inc. ("Wilshire"), incorporated in California in 1990, has its principal place of business in Carlsbad, California. Wilshire's common stock is registered with the Commission pursuant to Section 12(g) of the Exchange Act and is traded on the American Stock Exchange. B. The Facts 1. Background During fiscal years 1993 and 1994, Wilshire developed, manufactured and marketed medical, clean room and transdermal (through the skin) drug delivery products. During fiscal 1993, Wilshire introduced two new products, a transdermal appetite suppressant called "Trimpatch" that had not completed testing and a clean room product known as the pipe plug. Wilshire intended to sell the TrimPatch product in foreign countries and knew in early 1993 that it needed to obtain foreign government approvals before it could do so. Wilshire never obtained such approvals. As stated below, from at least the second quarter of fiscal year 1993 through January 1994, Wilshire materially overstated its earnings in press releases and periodic financial reports filed with the Commission. Wilshire overstated its financial statements primarily by improperly recognizing approximately $2.7 million of revenue from conditional sales of its TrimPatch and pipe plug products.2/ In addition, Wilshire materially 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. 2/ Generally Accepted Accounting Principles ("GAAP") require that revenue be recognized when merchandise is exchanged for cash or claims to cash and when goods are delivered. Financial Accounting Standards Board Statement of Concepts No. 5 83 a & b. GAAP also requires that revenue should not be recognized when the buyer's obligation to the seller is contingent on resale of the product. Financial Accounting Standards Board Statement No. 48. In this case, Wilshire's sales were conditional, and Wilshire, therefore, had no claim to cash, had not delivered the goods and should not have recognized revenue from such sales. ==========================================START OF PAGE 3====== overstated its earnings by improperly recognizing a $1.7 million gain from a related party asset sale and a $1 million vendor claim. Wilshire also issued false press releases concerning its earnings, business prospects and ability to meet analysts' expectations. 2. Wilshire Materially Overstated Its Second Quarter 1993 Revenues and Earnings On May 28, 1993, the last business day of Wilshire's second quarter, Wilshire improperly recognized $216,000 of revenue from a conditional sale of TrimPatch. In a July 2, 1993 press release and in a Form 10-QSB filed with the Commission on July 15, 1993, Wilshire reported second quarter revenue of over $2.5 million and pre-tax earnings of $413,000. As a result of improperly recognizing revenue on this conditional sale of TrimPatch, Wilshire overstated its second quarter revenue by $216,000, or 9%, and pre-tax income by approximately $131,000, or 47%. 3. Wilshire Materially Overstated Its Third Quarter 1993 Revenues and Earnings and Issued False Press Releases In a press release dated September 10, 1993, and in its third quarter 1993 Form 10-QSB filed with the Commission on September 27, 1993, Wilshire reported quarterly pre-tax earnings of $468,000 and revenues of almost $3.1 million. As a result of improperly recognizing a combined $1.34 million in revenue from conditional sales of TrimPatch and pipe plugs, Wilshire overstated its reported third quarter revenue by over 77%. Without recognition of revenue from these purported sales, Wilshire would have incurred a pre-tax loss for its third quarter of about $373,000, approximately $840,000 less than the reported pre-tax income of $468,000. Wilshire also misrepresented in its September 10, 1993 press release that: Wilshire had "shipped" 2.7 million units of TrimPatch to a distributor in Mexico; Wilshire had a "contractual backlog" of 23 million TrimPatch units to be shipped over the following 12 months; and Wilshire expected "additional" approvals for the TrimPatch in the next 30 days. Each of these representations was false. In fact, Wilshire had not "shipped" 2.7 million units of TrimPatch to a distributor but had received only a conditional order for 2.7 million TrimPatch units. Wilshire also had only a sales forecast, but no signed contracts, for 23 million TrimPatch units and, therefore, did not have a "contractual backlog." Finally, no country had approved the TrimPatch for sale, let alone the "additional" countries referred to in the release. 4. Wilshire Materially Overstated Its Fourth Quarter 1993 and Fiscal 1993 Revenues and Earnings and Issued False Press Releases ==========================================START OF PAGE 4====== On November 12, 1993, just 18 days before the fiscal year end, Wilshire issued a press release stating that "We [Wilshire] believe that the analysts' estimate of $.55 and $1.80 [earnings per share] for fiscal [years] 1993 and 1994 are still reasonable." This statement was false and misleading. This statement of earnings per share was based, in part, on the earnings for the second and third fiscal quarters of 1993, which Wilshire had materially overstated. At the time Wilshire issued this statement, Wilshire's second and third quarter reported earnings were overstated because it had improperly included the conditional TrimPatch and pipe plug sales described above. Then on December 22, 1993, Wilshire issued another press release that contained the following false material statements: Wilshire had received approval from the government of Mexico to sell the TrimPatch freely throughout Latin America; and Wilshire had received approval and registered to sell the TrimPatch in Hong Kong and Taiwan. In fact, Wilshire had not received any approvals to sell the TrimPatch and had not registered to sell the TrimPatch in Hong Kong and Taiwan. Finally, on January 21, 1994, Wilshire issued a press release that reported fourth quarter fiscal 1993 pre-tax earnings of almost $1.1 million and pre-tax earnings for fiscal 1993 of over $2.1 million on revenues of $11 million. Wilshire fraudulently overstated its fourth quarter 1993 pre-tax earnings in this release by over $6 million; Wilshire had, in fact, incurred a fourth quarter pre-tax loss of over $4.9 million. Similarly, Wilshire overstated its fiscal 1993 pre-tax earnings by $6.6 million, as Wilshire had, in fact, incurred a pre-tax loss of $4.5 million for fiscal 1993. Wilshire falsely inflated its earnings in this release by, among other things, improperly recording in the last week of Wilshire's fiscal 1993 four transactions: a $1.7 million gain from Wilshire's sale of an operating unit to a party related to Wilshire, reported over the objections of its auditors; $604,800 in revenue from another conditional sale of TrimPatch; $1 million from a claim against a supplier, which claim was disputed by the supplier and, in any event, was uncollectible; and $1 million in revenue from another conditional sale of pipe plugs. C. Wilshire Violated the Federal Securities Laws 1. Violations of the Antifraud Provisions: Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder Wilshire violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by preparing, publicly disseminating and filing with the Commission materially false and misleading financial statements and preparing and publicly issuing materially false and misleading press releases regarding Wilshire's business and ==========================================START OF PAGE 5====== earnings prospects. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder make it unlawful for any person, directly or indirectly, in connection with the purchase or sale of a security, to make an untrue statement of material fact, omit to state a material fact, use any device, scheme or artifice to defraud, or engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person. The "in connection with" requirement may be satisfied with a showing that the respondent's acts resulted in the issuer making a public announcement or filing a report with the Commission that could reasonably be expected to have caused investors to trade in the issuer's securities. See SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1171 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). The respondent must also have acted with scienter, which includes recklessness. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 (1976); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en banc), cert. denied, 499 U.S. 976 (1991). Misrepresentations or omissions will be deemed material if there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision. See Basic Inc. v. Levinson, 485 U.S. 224, 231 32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). As discussed, Wilshire disseminated financial statements that overstated its fiscal 1993 second quarter, third quarter, fourth quarter and year-end revenue and pre-tax income by improperly recognizing revenue on conditional sales of TrimPatch and pipe plugs. In its announced fourth quarter and year-end financial statements that were attached to its January 21, 1994 press release, Wilshire also overstated its pre-tax income by improperly recognizing the sale of an operating unit and a claim against a supplier. Wilshire also issued press releases that misrepresented the approval status of its TrimPatch product and misrepresented its ability to meet earnings expectations for fiscal 1993. Wilshire's misrepresentations were material. Wilshire overstated its second quarter 1993 pre-tax income by about 47% and reported substantial pre-tax income for its third and fourth quarters of 1993 and its fiscal 1993 when it had actually incurred substantial pre-tax losses in those periods. Wilshire also acted with scienter.3/ Through its officers and a director, Wilshire improperly recorded revenue and earnings, in some instances reporting such revenue and income against the specific warnings of its auditor. 3/ The scienter of Wilshire's officers is imputed to Wilshire. SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972). ==========================================START OF PAGE 6====== 2. Violations of the Reporting Provisions: Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 Thereunder Section 13(a) of the Exchange Act and Rule 13a-13 thereunder require issuers with securities registered pursuant to Section 12 of the Exchange Act, such as Wilshire, to file with the Commission quarterly reports on Form 10-QSB. Inherent in these provisions is the requirement that such filings be accurate; therefore, an issuer violates these provisions when it files a Form 10-QSB that contains materially false or misleading information. SEC v. Falstaff Brewing Corp., 629 F.2d 62, 72 (D.C. Cir. 1980); Savoy Indus., Inc., 587 F.2d at 1165. Rule 12b-20 under the Exchange Act similarly requires that these reports contain any material information necessary to make the required statements made in the reports not misleading. Wilshire violated these provisions when it reported materially false earnings and pre-tax income in its Forms 10-QSB filed with the Commission for its second and third quarters of fiscal 1993. Wilshire overstated its fiscal 1993 second and third quarter revenues reported in Forms 10-QSB by 9% and 77%, respectively. Wilshire also overstated its reported fiscal 1993 second and third quarter pre-tax income by approximately $131,000 and $840,000, respectively. 3. Violations of the Books and Records Provisions: Section 13(b)(2)(A) of the Exchange Act Section 13(b)(2)(A) of the Exchange Act requires every issuer that has securities registered pursuant to Section 12 of the Exchange Act, such as Wilshire, to "make and keep books, records, and accounts, which in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer." Wilshire violated the books and records provisions of Section 13(b)(2)(A) of the Exchange Act. Wilshire maintained books and records containing accounting entries and documents by which Wilshire fraudulently supported its overstated revenue and earnings. Specifically, Wilshire recorded accounting entries that fraudulently recorded conditional sales, the sale of a division to a related party and an unsettled claim. 4. Internal Control Violations: Section 13(b)(2)(B) of the Exchange Act The internal control provisions of Section 13(b)(2)(B) of the Exchange Act require issuers with securities registered under Section 12 of the Exchange Act, such as Wilshire, to devise and maintain a system of internal accounting controls sufficient to reasonably assure, among other things, that transactions are ==========================================START OF PAGE 7====== recorded as necessary to permit preparation of financial statements in conformity with GAAP. Wilshire's internal control system was materially inadequate to ensure that Wilshire's transactions were recorded in its books and records and reported in its financial statements in conformity with GAAP. Specifically, Wilshire had inadequate internal controls to assure that Wilshire properly recorded conditional sales, the sale of a division to a related party and an unsettled claim. D. CONCLUSION Based on the foregoing, the Commission finds that Wilshire violated Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20 and 13a-13 thereunder. IV. Based on the foregoing, the Commission deems it appropriate to accept the Offer of Settlement of Wilshire and accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Wilshire cease and desist from committing or causing any violations and any future violations of Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 10b-5, 12b-20 and 13a-13 thereunder. By the Commission. Jonathan G. Katz Secretary