UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 39506 / December 31, 1997 Accounting and Auditing Enforcement Release No. 1002 / December 31, 1997 Administrative Proceeding File No. 3-9521 : : In the Matter of : ORDER INSTITUTING : PROCEEDINGS PURSUANT TO New Jersey Resources Corp., : SECTION 21C OF THE Laurence M. Downes and : SECURITIES EXCHANGE ACT Glenn C. Lockwood, : OF 1934, MAKING FINDINGS AND : ISSUING CEASE-AND-DESIST ORDER Respondents. : : : I. The Commission deems it appropriate and in the public interest that public proceedings be, and they hereby are, instituted pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") to determine whether New Jersey Resources Corp. ("NJR") violated Sections 10(b), 13(a) and 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a- 13 thereunder, and whether Laurence M. Downes and Glenn C. Lockwood caused NJR's violation of Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder. II. Simultaneously with the institution of these proceedings, NJR, Downes and Lockwood have submitted Offers of Settlement, which the Commission has determined to accept. NJR, Downes and Lockwood, without admitting or denying the findings herein, except the jurisdiction of the Commission with respect to the matters set forth herein, which is admitted, have consented to the issuance of this Order Instituting Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings and Issuing Cease-and-Desist Order ("Order"). ======END OF PAGE 1====== III. Accordingly, IT IS ORDERED that proceedings pursuant to Section 21C of the Exchange Act be, and hereby are, instituted. On the basis of this Order, and the Offer submitted by Respondents, the Commission makes the following findings:<(1)> A. Summary This matter involves a transaction between affiliates that allowed NJR to avoid a material writedown. More specifically, this matter concerns the valuation of oil and gas properties on the basis of long-term natural gas supply and purchase contracts, which, taken together, provided for the delivery of gas between affiliates of the issuer. The supply contracts contained initial prices that were above the then prevailing spot price for gas and that subsequently escalated, with seasonal variation, over the 18- year life of the supply contracts. The terms of the supply and purchase contracts mirrored each other, so that an unaffiliated middleman inserted into the transaction incurred no significant economic risk. NJR utilized the contract prices to avoid a write-down under the full-cost ceiling test set out in Regulation S-X. This improper accounting for the transaction caused a material misstatement in NJR's consolidated financial statements. B. Respondents A. New Jersey Resources Corporation is a New Jersey holding company. NJR's common stock is registered pursuant to Section 12(b) of the Exchange Act and is traded primarily on the New York Stock Exchange. B. Laurence M. Downes, 39, was, during all relevant times, NJR's Chief Financial Officer. C. Glenn C. Lockwood, 36, a certified public accountant, was, during the events described in this Order, NJR's Controller. C. Facts During its fiscal year ended September 30, 1992 ("FY 1992"), NJR was engaged primarily in natural gas distribution through one of its subsidiaries. Other subsidiaries engaged in oil and gas exploration and production, and cogeneration and independent power production. NJR's sub- sidiaries included NJR Energy Corporation ("NJR Energy"), an oil and gas exploration and production company, and New Jersey Natural Gas Company ("NJNG"), a public utility with over 320,000 customers. NJR's financial statements, as incorporated in its Commission filings, were consolidated with those of its subsidiaries, including NJNG and NJR Energy. <(1)> The findings herein are made pursuant to Respondents' Offers of Settlement and are not binding on any other person or entity in this or any other proceeding. ======END OF PAGE 2====== NJR Energy utilized the full-cost method of accounting for oil and gas producing activities as set forth in Rule 4-10 of Regulation S-X.<(2)> In essence, this rule permits the capitalization of exploration and development costs, subject to a full-cost ceiling test.<(3)> This ceiling test requires a company to perform a calculation in order to test for impairment of value of the capitalized costs associated with its oil and gas properties. In performing this quarterly test, the present value of estimated future net revenues from the oil and gas properties was to be "computed by applying current prices of oil and gas (with consideration of price changes only to the extent provided by contractual arrangements)." Regulation S-X, 4-10(k)(6)(1992). If the capitalized costs associated with its oil and gas properties are impaired, then the company is required to write down the recorded value of these properties by the amount of the impairment, with a corresponding charge to operations. During the winter of 1991-92, NJR and NJR Energy learned that valuing NJR Energy's oil and gas properties on the basis of spot market prices might result in a multimillion dollar write-down of those properties for the quarter ending March 31, 1992. Such an amount would have been material to NJR's consolidated financial statements at March 31, 1992. NJR avoided this result by implementing a plan under which NJR Energy would sell gas to a third party middleman under the terms of a long term contract that provided for initial and subsequent prices sufficient to avoid a write-down. The middleman would, in turn, sell the gas to NJNG under another long-term contract incorporating a predetermined margin over the price at which it had acquired the gas from NJR Energy. During the first quarter of calendar 1992, NJNG, NJR Energy and NJR concluded such an arrangement with a third party, to begin April 1, 1992 with respect to certain production and October 1, 1992 with respect to other production, and extend for eighteen years. The arrangement was reflected in three contracts; the first two called for NJR Energy and one of its subsidiaries to supply a certain quantity of gas to the middleman (collectively, the "supply contracts"), and the third provided for the further transfer of that and other gas from the middleman to NJNG ("the purchase contract"). The initial and subsequent prices enabled NJR Energy to avoid recognizing an impairment under the full cost ceiling test at March 31, 1992. The price paid by NJNG to the middleman exceeded, by a set margin, the price at which the middleman purchased the gas from NJR Energy. <(2)> Alternatively, oil and gas companies can account for their exploration and production activities under the successful efforts method of accounting, which requires failed exploration costs to be reported as current period expenditures and permits the capitalization of exploration and development costs related to commercially viable reserves. <(3)> Rule 4-10(i)(4)(1992); now Rule 4-10(c)(4). ======END OF PAGE 3====== NJR, in its Form 10-Q for the second quarter ended March 31, 1992 reported total assets of $723,076,000, net income of $20,391,000 and earnings per share of $1.43. Had NJR Energy valued its oil and gas properties at spot prices, and recognized an impairment under the full cost ceiling test, the company would have been required to write-down the value of its assets by what the company calculates to be approximately $6.3 million. This would have resulted in the company's reported net income for that quarter being reduced by a similar amount and its $1.43 per share reported earnings for the quarter being reduced by 44 cents per share to 99 cents per share. Note 6 to NJR's consolidated financial statements for the second quarter ended March 31, 1992 stated: "NJR Energy satisfied the requirements of the full-cost ceiling test as of March 31, 1992 due primarily to long- term gas contracts covering about 60% of NJR Energy's current production." This note made no reference to the fact that the NJR subsidiaries were involved in the transaction, or to the lack of significant risk assumed by the middleman. It did not disclose that one of the agreements was not, at that time, performing, because payments and deliveries were not scheduled to begin until October. Similarly, these consolidated financial statements contained in NJR's second quarter Form 10-Q did not disclose the magnitude of the write-down NJR would have faced had it recognized an impairment of assets under the full-cost ceiling test, or what such an effect on net income and earnings-per-share would have been. Lockwood and Downes each signed this Form 10-Q, which Lockwood also assisted in preparing. Both were aware that the financial statements incorporated in that filing did not reflect any impairment of NJR Energy's oil and gas properties and that this was the result of NJR's reliance on the arrangement described above to satisfy the requirements of the full- cost ceiling test. Both either knew or should have known that neither in the notes to the financial statements, nor elsewhere in that report did the company provide appropriate disclosure of the actual nature of the arrangement described above. NJR's accounting treatment of its subsidiary's oil and gas properties also materially affected its year end consolidated financial statements.<(4)> In its annual report on Form 10-K for FY 1992, NJR reported total assets of $693,548,000, net income of $23,459,000 and earnings per share of $1.64. NJR Energy's failure to recognize an impairment of the carrying value of its oil and gas properties during that fiscal year of approximately $6.3 million increased the company's net income by the same amount and its earnings per share by 44 cents. Moreover, the disclosure omissions in the March 31, 1992 Form 10-Q concerning, among other things, the related party nature of the arrangement <(4)> The consolidated financial statements included in the Form 10-Q for the intervening quarter, that ended June 30, 1992, were also inaccurate in that they reflected oil and gas properties overstated by $6.3 million. Downes and Lockwood signed the Form 10-Q for that quarter. ======END OF PAGE 4====== with the middleman were repeated in NJR's 1992 Form 10-K. Lockwood and Downes each signed that report. D. Violations 1. NJR violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, 13a-13 thereunder. Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers of securities registered pursuant to Section 12 of the Exchange Act to file certain annual and quarterly reports with the Commission. Rule 12b-20 under the Exchange Act requires that these reports include any material information necessary to make the statements made therein not misleading under the circumstances in which they are made. Implicit in these rules is the requirement that the reports be true and correct. SEC v. IMC International, Inc., 384 F. Supp. 889, 893 (N.D. Tex.), aff'd mem., 505 F.2d 733 (5th Cir. 1974), cert. denied sub nom. Evans v. SEC, 420 U.S. 930 (1975). The financial statements contained in NJR's March 31, 1992 Form 10-Q and FY 1992 Form 10-K materially overstated net income and earnings per share as a result of the company's failure to recognize the impairment of NJR Energy's oil and gas properties, as required by Regulation S-X, Rule 4- 10. That rule requires that the value of reserves underlying the oil and gas properties be based on current (spot market) prices except "to the extent provided by contractual arrangements." Regulation S-X, Rule 4- 10(k)(6)(1992). The contractual arrangements contemplated by the Rule are bona fide agreements that shift the risk of changes in gas or oil prices to a third party purchaser. An agreement between different subsidiaries of the reporting entity does not achieve this purpose. The contracts in this matter, taken together, did no more than provide for the delivery from NJR Energy to NJNG of quantities of gas and allowed NJR Energy to receive initial and subsequent prices sufficient to avoid a write-down. The terms of the supply contracts mirror those of the purchase contract, except as to quantity, so that the middleman assumed no significant risk in connection with the arrangement. Furthermore, perfor- mance under one of the contracts with respect to the delivery of certain gas production was not to begin until October 1, 1992, so that the contract was not fully performing by the end of the March 31, 1992 quarter. In sum, this arrangement, which was entered into for the specific purpose of avoiding a write-down under the full cost ceiling test, failed to transfer significant risk to a bona fide third party, and therefore did not comport with the requirements of Regulation S-X. Furthermore, the description of the arrangement for the sale of NJR Energy's gas production contained in those filings was materially false and misleading in that it did not disclose, among other things, the underlying related party nature of the transactions as required by generally accepted ======END OF PAGE 5====== accounting principles<(5)> and that the effects of the contracts were not eliminated in consolidation. These omissions violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1 and 13a-13 thereunder. 2. Downes and Lockwood caused NJR's violations of Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder. By virtue of their involvement in the events described above and their training, professional experience, and position within the company, Downes and Lockwood knew or should have known that the contractual arrangement did not comport with the requirements of Regulation S-X, and was not reported in accordance with the periodic reporting requirements of the Exchange Act. As a result, Downes and Lockwood caused NJR's violations of Section 13(a) and Rules 13a-1 and 13a-13 thereunder by signing and causing to be filed NJR's Form 10-Q for the quarter ended March 31, 1992 and its Form 10-K for FY 1992. 3. NJR violated Section 10(b) of the Exchange Act and Rule 10b- 5 thereunder. A violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder occurs when material misstatements or omissions are made in Commission filings and trading occurs thereafter in the securities of the filing company. See Basic, Inc. v. Levinson, 485 U.S. 224, 230 (1988); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 860-82 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The company violated Section 10(b) and Rule 10b-5 when it filed the false and misleading reports described above with the Commission. 4. NJR violated Section 13(b)(2)(A) of the Exchange Act. Section 13(b)(2)(A) of the Exchange Act requires every issuer of securities registered under Section 12 of the Exchange Act to make and keep books, records and accounts, which, in reasonable detail, accurately and fairly reflect its transactions and the disposition of its assets. NJR violated this provision by failing to properly record, in the March 31, 1992 quarter, an impairment of the value of its subsidiary's oil and gas properties, as required by Regulation S-X, Rule 4-10. IV. Based upon the foregoing, the Commission finds that: A. NJR violated Sections 10(b), 13(a), 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and 13a-13; and B. Laurence M. Downes and Glenn C. Lockwood caused NJR's violations of Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13. <(5)> Statement of Financial Accounting Standards No. 57. ======END OF PAGE 6====== V. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Respondents' Offers of Settlement. VI. Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that A. NJR cease and desist from committing any violations, and any future violations, of Sections 10(b), 13(a), 13(b)(2)(A) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1, and 13a-13; and B. Laurence M. Downes and Glenn C. Lockwood cease and desist from causing any violations, and any future violations, of Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 7======