The co-founders of a Florida based computer company were named as Respondents in SEC administrative proceedings. The actions centers on significant internal control difficulties regarding the inventory which, rather than being remedied, were concealed from the auditors and misrepresented in filings. Improper accounting regarding the inventory was also used to accelerate borrowing under a line of credit. Ultimately the firm failed, tumbling into bankruptcy. In the Matter of Edward L. Cummings, CPA, Adm. Proc. File No. 3-15991 (July 30, 2014); In the Matter of Marc Sherman, Adm. Proc. File No. 3-15992 (July 30, 2014).
Messrs. Sherman and Cummings founded QSGI, Inc., in 2001. The firm was a reseller of, and maintenance provider for, used computer equipment. Mr. Sherman served as CEO while Mr. Cummings acted as the CFO.
The firm had inventory at facilities in New Jersey and Minnesota. About 50% of the reported gross inventory was in New Jersey. The Minnesota facility had about 40% of the reported gross inventory. Prior to its 2009 filing for bankruptcy, QSGI had recurring inventory problems. For example, certain inventory was shipped into its facilities and out with out making the necessary entries in the books and records; items such as parts were removed without recording that fact; in some instances component parts were stripped off without the appropriate entries being made. The books and records of the company were thus incorrect.
At the Minnesota facility the difficulties escalated beginning in 2007. Those were driven in part by a manufacturer’s change in policy which caused QSGI to alter its business from selling machines to just parts. This change, in turn, aggravated the issues with removing components from inventory without making the proper entries. In addition, new personnel intended to replace certain departing staff members did not have the appropriate background. While the company attempted to introduce new controls in 2008, it failed.
In mid-2008 QSGI executed a revolving credit facility. Under the terms of the facility QSGI’s inventory and accounts receivable factored into a weekly calculation of the borrowing base. Beginning in 2008, and continuing through the first half of 2009 before the bankruptcy filing, the company in certain instances exceeded the borrowing limit or would not be able to borrow enough to continue operations. Accordingly, Mr. Sherman would cause the firm not to report the calculations to the lender. To increase the base he would accelerate recognition of accounts receivable and/or the receipt of product into inventory. The lending base would then be recalculated.
The inventory difficulties were not reported to the outside auditors. Rather in management representation letters to the auditors affirmative misrepresentations were made or material facts were omitted. False management reports were included in filings made with the Commission. False certifications were also executed.
Each of the Orders alleges violations of Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) and the related rules. The proceeding as to Mr. Sherman will be set for hearing. Mr. Cummings resolved the proceeding in which he is named as a Respondent. He consented to the entry of a cease and desist order based on the Sections cited in the Order and the related rules. He is also denied the privilege of appearing and practicing before the Commission as an accountant with a right to reapply after 5 years. Mr. Cummings is precluded from serving as an officer or director of a public company for a period of five years. He will pay a civil money penalty of $23,000.