2
3
4
5
6
7
8
9
10
11
12
13
14
As previously reported in the third fiscal quarter 2010 earnings release of July 22, 2010, after receiving allegations regarding possible violations of our gifts, travel and entertainment policy for activities in the Asia Pacific (APAC) region by a few employees, we initiated an investigation of these policy and corresponding internal control issues, and any possible related violations of applicable law, including the Foreign Corrupt Practices Act (FCPA). We voluntarily disclosed the allegations to the United States Department of Justice (DOJ) and the United States Securities and Exchange Commission (SEC). The investigation has been under the direction of the Audit Committee, comprised solely of independent directors, utilizing outside counsel, and focused on the APAC region. For completeness purposes, the investigation reviewed certain other foreign regions where no allegations have been made. At that time, we believed the investigation was substantially complete, pending input from the DOJ and the SEC. We have been providing the DOJ and SEC with updates and our proposed remediation plan.
15
Digi has now received confirmation through discussions with representatives of the DOJ and the SEC that they will not be initiating any enforcement proceedings against Digi, including not seeking any monetary or other sanctions.
The investigation identified violations of company policy that primarily involved three individuals in Hong Kong and our Chief Financial Officer. The investigation also found an unsubstantiated accrued liability recorded in Hong Kong. All four individuals were terminated or had resigned from the company as of May 12, 2010. In the three and nine months ended June 30, 2010, we incurred additional general and administrative expense of $1.0 million related to the cost of the investigation.
As a result of the allegations and the ultimate findings of the investigation, we performed an evaluation of our internal controls over financial reporting during the third fiscal quarter of 2010 to consider the implications of these findings. A discussion of our controls evaluation and changes in internal control over financial reporting, including remediation efforts appears in Part I, Item 4 of this Quarterly Report on Form 10-Q. While we determined that no adjustment was required to our previously reported consolidated financial statements, we recorded an immaterial out-of-period adjustment this period in order to correct the unsubstantiated accrued liability in Hong Kong.
16
17
18
19
20
21
22
23
24
25
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of June 30, 2010 to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and is accumulated and communicated to our management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
INVESTIGATION IN HONG KONG
The previously announced investigation, which was the result of allegations that we learned of in April 2010, was completed in July 2010 (refer to Note 11 of the Condensed Consolidated Financial Statements for more detail). Soon after learning of these allegations, the Company began to take immediate remedial actions. The investigation identified violations of company policy that primarily involved three individuals in Hong Kong and our Chief Financial Officer. The investigation also found an unsubstantiated accrued liability recorded in Hong Kong. All four individuals were terminated or had resigned from the company as of May 12, 2010.
As a result of the allegations and the ultimate findings of the investigation, we performed an evaluation of our internal controls over financial reporting during the third fiscal quarter of 2010 to consider the implications of these findings. We identified deficiencies in the design of the internal reporting structure in Hong Kong, as well as deficiencies in the design of certain controls in Hong Kong, including expense reviews, cash controls, review of Hong Kong financial information and account reconciliations in both Hong Kong and the corporate office, and in the competency of those performing financial accounting and reporting activities in Hong Kong. These deficiencies allowed inappropriate activities, such as those that ultimately led to the investigation and terminations and resignation noted above, to not be prevented or detected on a timely basis. We have determined based on a review of the internal reporting structure and controls at Hong Kong in comparison to our other locations that these issues were unique to the Hong Kong entity and that the Company’s other entities had controls in place that were operating and effective. While we determined that no adjustment was required to our previously reported consolidated financial statements, we determined that the aggregation of these control
26
deficiencies, combined with the influence and span of control of our former CFO in the Hong Kong region and collusion on the part of the individuals involved, resulted in a material weakness in the Company’s control environment. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. The control deficiencies at Digi could have resulted in a material misstatement of the consolidated financial statements that would not have been prevented or detected on a timely basis.
As described below, we determined that this material weakness was remediated as of June 30, 2010.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been changes in internal control over financial reporting during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting. In response to the material weakness discussed above, the Company implemented the following remedial actions which were all completed as of June 30, 2010:
These activities have been incorporated into our internal control structure and were in place as of June 30, 2010 and will be sustained going forward such that the underlying control deficiencies that aggregated to the material weakness have been substantially remediated as of June 30, 2010, and therefore the material weakness no longer exists as of June 30, 2010.
27
28
29
30
31