The Securities and Exchange Commission (SEC) has settled with Milwaukee-based Merge Healthcare and two former senior executives over their roles in an alleged accounting fraud that ultimately caused the company's stock price to drop by two-thirds during a seven-month period.
Under terms of the settlement, former CEO Richard Linden of Barrington, Ill., will pay a total of $590,000 and former Chief Financial Officer Scott Veech of Whitefish Bay, Wis., will pay a total of $280,000.
Linden and Veech are permanently enjoined from committing future violations of the antifraud provisions of the federal securities laws, and are barred from serving as an officer and director of a public company for five years. Additionally, Veech consented to the entry of an administrative order that suspends him from appearing or practicing before the commission as an accountant, with a right to reapply after three years. Merge is permanently enjoined from future violations of the internal controls, books and records, and reporting provisions of the federal securities laws.
Under its initial charges, the SEC alleged that Linden and Veech engineered a process where the medical imaging software and hardware provider improperly recognized revenue from sales that had not been fully completed with delivery of the software products, features or enhancements promised to customers.
The SEC further alleged that Linden, with Veech's knowledge, interfered with the audit confirmation process by instructing Merge sales personnel to tell some of the company’s customers not to disclose side agreements to Merge's outside auditor. Also, Linden signed at least 16 and Veech at least 14 false and misleading management representation letters to Merge's outside auditor.
"Linden and Veech went to deliberate lengths to disguise the timing and truth behind the sales of their software products and enhancements," said Merri Jo Gillette, director of the SEC's Chicago regional office. "The company's weak and ineffective internal controls allowed these corporate executives to carry out the fraud."
According to the SEC's complaint, Merge prematurely recognized revenue from 124 transactions between 2002 and 2005, many of which involved Merge's promises to customers of "hanging protocols" that provide radiologists with the ability to rearrange the sequence and orientation of images. Under the Generally Accepted Accounting Principles (GAAP) governing the recognition of revenue for software sales, Merge was required to defer revenue recognition of transactions with these promises until the enhancements to hanging protocols were actually delivered in 2005 and 2006.
The SEC also alleged that these fraudulent accounting practices caused Merge to overstate its net revenue by approximately 26 percent and overstate its net income by approximately 230 percent in annual and quarterly reports from its first quarter of 2002 through its second quarter of 2005. The accounting fraud ultimately cost the company more than $500 million in market capitalization.
Merge, Linden and Veech each agreed to settle the SEC's charges without admitting or denying the allegations against them.
"This has been a long and difficult process for the company, even though these issues happened several years ago. Employees, customers and shareholders all welcome the closing of this chapter of Merge’s history," said Justin Dearborn, Merge’s current CEO.