Enjoined Lawyer Disqualified

Chris G. Gunderson, Esq., Exchange Act Rel. 61234, December 23, 2009

Time since appeal – 1 year 11 months 5 days
Time since last brief – 1 year 3 months 21 days

Gunderson appealed from an ALJ decision permanently disqualifying him from practicing before the Commission under its Rule 102(e). The disqualification was based on an injunction entered against him for registration and antifraud violations involving Universal Express, Inc. See, SEC v. Universal Express, Inc., 475 F.Supp. 2d 412 (SDNY 2007), aff'd sub nom. SEC v. Altomare, 300 Fed. Appx. 70 (2d Cir. 2008 (per curium) (unpublished), cert. denied, 129 S. Ct. 2745 (2009). The Commission affirmed the sanction.

The district court found that pursuant to agreements drafted by Gunderson the company distributed more than 500 million shares of unregistered stock. The district court also found that Gunderson drafted fraudulent press releases for the company. It also found that Gunderson violated its injunctive order but declined to hold him in contempt due to the appointment of a receiver for Universal Express.

Given the egregious violations found by the district court one can only wonder why the Commission lingered over this matter for so long.

Commission Dismisses Case Against CPAs

Kevin Hall, CPA, Rosemary Meyer, CPA, Exchange Act Rel. 61162, December 14, 2009

Time since appeal – 1 year 10 months 8 days
Time since last brief – 1 year 6 months 24 days

The ALJ found no improper conduct by these two accounts and the Division of Enforcement appealed. The Commission dismissed the case – a very significant loss for enforcement.

One has to wonder why it took so long for the Commission to rule on this matter. The ALJ's initial decision was in January 2008. It is simply wrong for the Commission to delay resolution of these cases for so long. Here, two auditors' careers have been terribly damaged as a result of the Commission's failure to take its responsibilities seriously. It is simply not in the public interest for the Commission to delay resolution of these administrative cases. The public interest demands more. The audit that resulted from these proceedings was for fiscal year 1999, so final resolution of this matter took nine years.

Hall was the KPMG engagement partner and Meyer the senior manager on the audit of U.S. Foodservice, Inc. in 1999. Hall and Meyer were charged with violations of the Commissions Rule 102(e) that allows it to administratively discipline CPAs in connection with public company audits. It was uncontested that the company had engaged in a fraudulent earnings management scheme involving its accounting for promotional allowances from vendors. Two company officers were criminally convicted.

In order to prevail enforcement must prove that the auditors engaged in:

"'improper professional conduct [which] for accountants includes '[r]epeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards, that indicate a lack of competence to practice before the Commission.' The term 'unreasonable' signifies an ordinary or simple negligence standard. Discipline under Rule 102(e) may be appropriate when the repetition of such negligent conduct shows an accountant's lack of competence to practice before the Commission. The negligence-based standards in Rule 102(e)(iv)(B) are objective, measured by the degree of the departure from professional standards rather than the intent of the accountant. In applying these standards, the Commission does not evaluate actions or judgments in the light of hindsight; it focuses, instead, on what the accountant knew or should have known at the time an action was taken or a decision was made." (footnotes omitted)

Much of the opinion involves the details of GAAS requirements for the confirmation process. The auditors noted various discrepancies and according to the Commission did not engage in "best audit practices." The Commission nevertheless concluded that their conduct was not unreasonable. Some third party confirmations were not included in the work papers and there was no way to verify the auditor's testimony about their claimed exculpatory contents. However since GAAS does not require auditors to maintain all documents they rely on in their workpapers there was no basis for the Commission to find the conduct unreasonable.

The Commission rejected the ALJ's suggestion that the Commission has no jurisdiction over accountants who review but do not audit a company's quarterly financial statements.

The Commission rejected due process claims by Hall and Meyer based on the fact that the Commission, unknown to them, was conducting and investigation of their then counsel during the investigation. That investigation was concluded without any action being taken.

CPA's Motion To Lift Temporary Suspension After Injunction Denied

William D. Shovers, Exchange Act Rel. 59874, May 6, 2009.

The Commission instituted disciplinary proceedings against CPA Shovers under its rule 102(e) and temporarily suspended him from practicing before the Commission at the same time. Rule 102(e)(3) allows temporary suspensions pending a hearing on the merits if the respondent has been enjoined from securities law violations or found to have violated the securities laws in a Commission enforcement action. Shovers was enjoined in late 2008 after a jury in a Commission civil action found he had violated, inter alia, the antifraud provisions of the securities laws.

Shovers moved that the temporary suspension be lifted until the Commission had decided the case on the merits and also moved for a hearing. The Commission denied the motion to lift the temporary suspension noting that Shovers may not collaterally attack the injunction or findings in the civil case. Shovers' request for a hearing was granted and ordered that an expedited hearing take place before an administrative law judge.

Comment

In a footnote the Commission noted that it would presume that Shavers was not prejudiced by the temporary suspension pending the hearing as he did not allege any harm. Practitioners should note this and be prepared to argue harm resulting from such a suspension if they seek relief from the stay pending a hearing.

Adelphia Audit Partner Sanctioned - No Reliance On Prior Audits

Gregory M. Dearlove, AAER 2779

Time since appeal filed - 2 years, 4 months, 1 day.

Time since final brief filed - 2 years, 27 days.

Time since oral argument - 1 year, five months, 7 days.

Pages - 60

Footnotes - 168

Summary

This is a disciplinary proceeding against a CPA and arises from the Adelphia fraud. Respondent was formerly a partner at Deloitte & Touche and was the engagement partner for the audit of Adelphia for the 2000 audit of that firm. He was denied the privilege of appearing or practicing before the Commission with a right to reapply after four years.  He was also ordered to cease and desist violations of Exchange Act Section 13(a).  The ALJ had barred him from appearing before the SEC.

Adelphi filed for bankruptcy in June 2002 after disclosing related party transactions with the Rigas family that controlled the company.  As part of a settlement with the Department of Justice, Adelphia agreed to pay $715 million to a victims' restitution fund and the DOJ declined to file criminal charges.  In 2005 the Rigas settled civil charges brought by the Commission and consented to injunctive relief.  The Commission also brought an administrative action against Deloitte which the firm settled, among other things it agreed to a $25 million penalty and consented to findings it had "engaged in repeated instances of unreasonable conduct" concerning the 2000 audit of Adelphia.

This opinion contains a comprehensive discussion of the Generally Accepted Auditing Standards (GAAS) that apply to audits of public companies.  Among other things, "[u]nless and until an auditor obtains an understanding of the business purpose of material related party transactions, the audit is not complete."

Respondent argued that he should have been able to rely on the fact that the related party transactions had been subject to prior year audits.  The Commission rejected Dearlove's argument, stating "[W]e reject any suggestion that the conduct of prior auditors should be a substitute for the standards established by GAAS."  Further, it noted that rotation of auditors has long been required by the AICPA and federal law as a means of insuring impartiality. The Commission also rejected this defense on factual grounds, finding that the 2000 audit did not document how the prior audits were performed or what evidential matter supported those conclusions.  

Much of the opinion discusses highly technical accounting issues.  Those are summarized very briefly below.

The Commission noted that it was improper for Adelphia to net its related party receivables and payables.  Also, the company reflected a dramatic drop in the net figure, which the Commission found should have alerted the auditors to more carefully scrutinize this matter. Dearlove could not explain how the audit had tested this practice by the company.  The work papers do not reflect that the auditors gave any consideration to the propriety of this netting by the company.  The Commission found that Dearlove accepted the practice "primarily, if not solely" because the prior auditors had as well.

The ALJ rejected the Division of Enforcement's claim that Adelphia's treatment of various debt as a contingent, rather than a primary liability was wrong.  The Division did not appeal this finding.  Nevertheless, the Commission found that Dearlove's auditing of this was not in compliance with GAAS.  This is an important finding, accountants will be held liable for a GAAS violation even if the underlying accounting was appropriate.  Thus, getting to the right result is not a defense in a Rule 102(e) proceeding.  In support of this conclusion, the Commission noted that disclosures relating to the debt were not adequate.

Adelphia transferred debt from its subsidiaries to various Rigas controlled entities after the close of quarters, but nevertheless retroactively reflected the lesser debt amounts on the company's books. The Commission found this debt reclassification a violation of GAAP, even though there was no expert testimony that supported this conclusion.  The absence of expert opinion does not prevent the Commission from making findings as to the "principles of accounting."

The Rigas acquired Adelphia stock with funds borrowed jointly by themselves and Adelphia.  This debt was not recorded on Adelphia's books.  The Commission also found the auditors violated professional standards in their audit of these transactions.

The opinion contains a comprehensive discussion of the factors the Commission will consider when disciplining auditors.  It noted that auditors play a crucial rule in the system of public reporting as "[i]nvestors have come to rely on the accuracy of the financial statements of public companies when making investment decisions.  Because the Commission has limited resources, it cannot closely scrutinize every financial statement.  Consequently, the Commission must rely on the competence and independence of the auditors who certify, and the accountants who prepare, financial statements.  In short, both the Commission and the investing public rely heavily on accountants to assure corporate compliance with federal securities law and disclosure of accurate and reliable financial information."

It also noted that a negligent audit can inflict as much harm on investors as one that is conducted with an improper motive.  

The Commission found that it was appropriate to impose a cease and desist order against Dearlove for causing Adelphia's Exchange Act reporting violations.  In doing so it reiterated a three part test for "causing" liability namely: 1) a primary violation; 2) respondent contributed to the violation; and 3) respondent knew or should have known his conduct would contribute to the violations.  It further noted that negligence was sufficient to satisfy the knowledge requirement of the test.

The Commission rejected Dearlove's claim that the Commission's rule that set a deadline for trial judge to issue an opinion violates due process because here, a motion for a sixty day postponement of the trial was denied by the judge.   In rejecting this argument the Commission cited to the test set forth in Unger v. Sarafite, 376 U.S. 575 (1964) which noted that there is no mechanical test for deciding when denial of a continuance is so arbitrary as to violate due process.  The Commission noted that it has long articulated the test in terms of whether the denial "constituted 'an unreasoning and arbitrary insistence upon expeditiousness in the face of a justifiable request for delay.'"  In the past the Commission has rarely found a denial of due process when there were extraordinary circumstances for a postponement of trial, such as the respondent being left without counsel shortly before the hearing.  Here the judge's schedule allowed for 121 days between service of the order and completion of the hearing.  Further,  counsel was familiar with the matter as he had been involved in the matter for the two prior years when respondent's investigative testimony was taken.

Comment

The Commission's finding that Dearlove violated GAAS even though the accounting treatment of a debt item was appropriate is highly significant for auditors of public companies.  They can thus be held responsible for bad auditing practices even if the underlying accounting was valid.

Also noteworthy is the Commission's conclusion that it may make findings that accounting principles were not properly applied even absent expert testimony to support such a finding.  The Commission will make its own judgments about what constitutes proper accounting treatment of a transaction.

The Commission noted that under some circumstances "unreasonable conduct is not necessarily a less egregious disciplinary matter than either intentional or reckless conduct, or highly unreasonable conduct in circumstances warranting heightened scrutiny."

The Commission allowed respondent to reapply for reinstatement after four years. It stated, with little explanation, that it believed this sanction would encourage rigorous compliance with auditing standards, without being punitive.  This reversion to ipse dixit reasoning may cause the Commission issues before the court of appeals should an appeal be taken.

The Commission's finding that an auditor who signs an audit report after conducting an audit that does not comply with GAAS contributes to a violation of the reporting provisions is significant.

The Commission's ruling that there was no due process violation because the trial judge denied Dearlove's motion for a 60 day continuance after scheduling 121 days between the start of the proceedings and conclusion of the trial is one that practitioners should note.  This is another case where the Commission is clearly signaling that it will not interfere with scheduling or trial management decisions by its ALJs.  It pointed out that Commission rules specify such deadlines are not rigid and that the trial judge can petition the Commission to extend the deadline for rendering an initial decision.  Someone prone to sarcasm might note that the Commission took significantly longer than 121 days after oral argument to render its opinion, let alone the 300 days it allocated for the ALJ to conclude the trial and render an opinion.