UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 41038 / February 10, 1999 Accounting and Auditing Enforcement Release No. 1107 / February 10, 1999 Administrative Proceeding File No. 3-9825 ______________________________ : In the Matter of : : ORDER INSTITUTING PROCEEDINGS : PURSUANT TO RULE 102(e) OF THE MIGUEL A. CABRERA., JR., CPA, : COMMISSION’S RULES OF PRACTICE and M.A. CABRERA & CO., P.A. : AND FINDINGS AND ORDER OF : THE COMMISSION : Respondents. : : : I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that proceedings be, and they hereby are, instituted pursuant to Rule 102(e)[1] of the Commission's Rules of Practice with regard to Miguel A. Cabrera, Jr. and M.A. Cabrera & Co., P.A. Accordingly, IT IS HEREBY ORDERED that said proceedings be, and hereby are, instituted. II. Miguel A. Cabrera, Jr. ("Cabrera") and M.A. Cabrera & Co., P.A. ("Cabrera & Co.") (collectively "Respondents") have submitted Offers of Settlement ("Offers") to the Commission in which Respondents, prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R. § 201.1 et seq., and without admitting or denying any of the Findings of this Order Instituting Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice and Findings and Order of the Commission ("Order"), except that Respondents admit the jurisdiction of the Commission with respect to the matters set forth herein, solely for purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or in which the Commission is a party, consent to the issuance of the Order. Based upon the foregoing, the Commission deems it appropriate and in the public interest to accept the Respondents' Offers and to impose the sanctions consented to therein. III. The Commission makes the following findings: A. SUMMARY This case involves the audits by Cabrera & Co. of the financial statements of Madison Group Associates, Ltd. ("Madison Group" or "the Company") for the fiscal years ended September 30, 1992 and 1993, which Madison Group included in Annual Reports on Form 10-K that it filed with the Commission on March 5, 1993 and January 21, 1994, respectively. Cabrera & Co. improperly issued reports on Madison Group's financial statements for the above periods stating that it had conducted the audits in accordance with generally accepted auditing standards ("GAAS") and that the financial statements were presented in conformity with generally accepted accounting principles ("GAAP"). Cabrera performed or supervised substantially all of the audit procedures involved in these audits. As set forth below, the Staff alleges (a) that the Madison Group financial statements contained misrepresentations of material fact concerning certain of the assets on its balance sheets, and (b) that Respondents failed to conduct the audits of those financial statements in accordance with GAAS and therefore should not have issued the reports that were issued. B. RESPONDENTS 1. Miguel A. Cabrera, Jr. is a certified public accountant licensed in the State of Florida. He has practiced before the Commission within the meaning of Rule 102(e) of the Commission's Rules of Practice in connection with the audits by M.A. Cabrera & Co. of Madison Group's financial statements for the fiscal years ended September 30, 1992 and 1993. 2. M.A. Cabrera & Co., P.A. is a Florida professional association. It is, and at all relevant times was, partially owned by Cabrera. M.A. Cabrera & Co. served as Madison Group's independent accountant for the fiscal years ended September 30, 1992 and 1993. During its fiscal year 1994, Madison Group terminated M.A. Cabrera & Co. as its auditor. C. FACTS 1. Madison Group's Financial Statements Did Not Comply with GAAP. On March 5, 1993, Madison Group filed an Annual Report on Form 10-K with the Commission, which contained, among other things, audited financial statements as of September 30, 1992 and 1991 and for the fiscal years then ended. Madison Group reported in its 1992 financial statements total assets of $34.4 million, representing a 422% increase over total assets reported in the Company's 1991 financial statements. The purported increase of the Company's assets, resulting principally from acquisitions of media properties and mortgage notes receivable, was false because the cost of the media properties was materially overstated and because the Company did not own the mortgage notes receivable. Madison Group again reported the media properties and mortgage notes receivable at the same amounts in its 1993 financial statements, which the Company included in its Form 10-K filed with the Commission on January 21, 1994. a. Madison Group valued the media assets based on unrealistic appraisals. Madison Group's largest asset was an inventory of media products, consisting of three entertainment libraries of country and gospel music videos, special effects programming, and taped interviews of sports and entertainment personalities. In 1991, Madison Group acquired its first media library in exchange for 20,000 shares of its newly issued preferred stock and recorded the library at $4 million. In June 1992, Madison Group acquired two other media libraries and recorded these two libraries at $25.5 million. Madison Group acquired the two libraries in exchange for 64,000 shares of convertible preferred stock, 15,000 shares of its common stock, and a promissory note having a principal amount of $150, 000.[2] Madison Group used independent appraisal reports prepared by a single appraisal firm to assign values to the media library acquired in 1991 and the first of the two media libraries acquired in 1992. These appraisal reports purportedly established the fair values of the media assets. To record the second media library acquired in 1992, Madison Group purportedly used a preliminary fair value estimate of $16.5 million provided to the Company by the same appraisal firm because the appraisers had not completed an appraisal of the assets. In valuing the assets, the appraisers relied on estimates and assumptions about future sales of the media programming that were unrealistic and not attainable by the Company. Madison Group had no current or historical sales to support the estimates and assumptions made by the appraisers, and the Company had no realistic way of attaining or reaching the levels of market penetration and revenue production reflected in the appraisal reports. In addition to being new to the industry, the Company did not have the working capital necessary to compile, market, and syndicate the programming.[3] Thus, the appraisal reports were inadequate evidence of the values ascribed to the media libraries. The notes to the financial statements in both years disclosed that the company had not yet generated any revenues from the media products and that its ability to do so was dependent on its ability to secure necessary financing, and the company's 1993 MD&A section disclosed the need to sell securities to generate the capital to meet its business plan. An asset received by an entity in exchange for stock generally should be recorded at the fair value of the asset, that is, the amount of cash the asset would bring in a sale to an unrelated party. If such a value cannot be determined objectively and reliably and the future cash flows that may be generated by the asset itself are uncertain, then the asset should be recorded at a nominal value. In this instance, Madison Group did not acquire the media assets for cash, and the Company did not have the financial wherewithal to fulfill the assumptions in the appraisals. Madison Group should, therefore, have recorded the media assets at a nominal value.[4] b. Madison Group did not own the mortgage notes receivable. Madison Group's fiscal year 1992 and 1993 financial statements additionally were not in conformity with GAAP because the Company did not have a valid claim to the $3.8 million mortgage notes receivable. The Company disclosed in its fiscal year 1992 and 1993 financial statements and notes thereto and elsewhere in its 1992 and 1993 Forms 10-K that it had acquired the mortgage notes, which had a face amount of $11,875,000, in June 1992 in exchange for 6,764,410 shares of its common stock. In actuality, the parties never consummated the transaction because Madison Group never issued its stock or provided any other consideration in exchange for the notes. Therefore, the Company should not have reported the mortgage notes receivable as assets in its balance sheet.[5] 2. Respondents Engaged in Improper Professional Conduct. Prior to accepting the audit engagement for Madison Group's 1992 financial statements and continuing throughout their audits of the Company's 1992 and 1993 financial statements, Respondents engaged in a pattern of improper professional conduct, which led to (1) their having failed to audit the Company's 1992 and 1993 financial statements in accordance with GAAS and (2) their having issued unqualified audit reports on the Company's 1992 and 1993 financial statements when they should have qualified or disclaimed an opinion. a. Respondents failed to make reasonable inquiries of the predecessor auditor. Respondents engaged in improper professional conduct when they failed to make reasonable inquiries of the predecessor auditor prior to and during their audit of Madison Group's 1992 financial statements. American Institute of Certified Public Accountants, Statement on Auditing Standards ("SAS"), No. 7, "Communications Between Predecessor and Successor Auditor", 1975, codified as AU Section 315A.08. Had they made such inquiries, Respondents would have learned that the predecessor auditor had determined, during his 1992 audit procedures, that Madison Group needed to have the media assets re-evaluated by an independent specialist.[6] The predecessor auditor had concluded that the independent appraisal reports held by the Company did not constitute sufficient competent evidential matter to support the recorded amounts of media assets because the Company was unable to provide him with any evidence of revenues generated by the assets and because the assets had continued to be nonproductive. Respondents, however, accepted those same independent appraisal reports as their principal source of audit evidence to support the media assets in the 1992 audit. Moreover, Respondents accepted a preliminary estimate of the fair value of the Company's largest media library because the appraisers had not completed an appraisal of the library, which accounted for more than half of the Company's reported assets at fiscal year end 1992. No final appraisal report ever was issued by the appraiser. Had they made reasonable inquiries of the predecessor auditor prior to or during his 1992 audit, Respondents would additionally have learned that the acquisition and ownership of the mortgage notes receivable required further investigation. The predecessor auditor had learned from a third party that second mortgages on approximately 70 farm properties serving as collateral to Madison Group's mortgage notes receivable were not valid. Respondents' improper professional conduct continued into their audit of Madison Group's 1993 financial statements when they learned from Madison Group's management of the predecessor auditor's concerns regarding the valuation of the media assets and ownership of the mortgage notes receivable relating to the 1992 financial statements. They learned that the predecessor auditor would not reissue his audit report on the Company's 1991 financial statements until he had performed additional audit tests and had obtained sufficient audit evidence to support the recorded amounts of media libraries in the 1991 financial statements. The import of these communications should have caused Respondents to conclude that there was a high degree of intrinsic audit risk and reassess the scope of their 1993 audit procedures. The communications should additionally have caused Respondents to question whether the 1992 financial statements, on which they had rendered an unqualified audit report with a supplementary explanatory paragraph, were free of material misstatement and presented in conformity with GAAP. Respondents, however, neither contacted the predecessor auditor about these matters nor did they require the Company to have the media assets reevaluated by a specialist or otherwise obtain more persuasive evidence to support the reported amounts of media assets in the 1993 financial statements. Instead, Respondents accepted the same fair value estimates for the media assets made by the appraisers in the two prior fiscal years -- even though Madison Group had never generated any revenues from the assets. SAS No. 53, "The Auditor's Responsibility to Detect and Report Errors and Irregularities", 1988, codified as AU Section 312.17, states that "...higher risk may cause the auditor to expand the extent of procedures applied, ...or modify the nature of procedures to obtain more persuasive evidence." b. Respondents failed to obtain sufficient competent evidential matter. (i). Improper reliance on a specialist. Respondents relied on the appraisal reports as their principal source of audit evidence to support the value of the media assets without having- first determined whether they could rely on the qualifications and work of the appraisers. SAS No. 11, "Using the Work of a Specialist", 1975, codified as AU Section 336.08, states that the auditor should consider the specialist's experience in the type of work under consideration. In this instance, the appraisers specialized in real estate valuations and had no experience in valuing media properties. SAS No. 11, codified as AU Section 336.12, states that prior to using the findings of the specialist, the auditor should understand the methods and assumptions used by the specialist and evaluate whether the specialist's findings support the related assertions in the financial statements. Respondents failed to properly evaluate whether use of the appraisals was appropriate audit evidence. For example, the appraisal reports contained revenue and cash flow projections, but Respondents failed to determine whether there had been sufficient verifiable revenues generated from the media properties to support the projections. Had they made inquiry of management, the prior owners of the libraries, or the predecessor auditor, Respondents may have learned that there had not been sufficient revenues. Respondents should have questioned the appropriateness of the assumptions used by the specialist because Madison Group did not have the financial wherewithal to support the assumptions. The appraiser assumed that the principal source of revenues to be generated from the libraries would come from Madison Group's sales of advertising time that it might receive from cable television stations during the airing of programs. The appraiser did not take into account the fact that Madison Group had no experience in this area and, in fact, had made no sales of advertising time. (ii). Mortgage notes receivable Respondents failed to obtain sufficient competent evidential matter to support the valuation and ownership rights of the mortgage notes receivable. Madison Group purportedly acquired the mortgage notes receivable through a complicated series of transactions with a Turks and Caicos Trust. Respondents relied upon a written confirmation from the Trust of its indebtedness to Madison Group to audit the mortgage notes receivable for 1992. However, Respondents did not attempt to corroborate Madison Group management's assertion that Madison Group had issued 6,764,410 shares of its common stock to the Trust, nor did they obtain evidence demonstrating that the Trust had the financial resources to make installment payments on the mortgage notes. Moreover, because Respondents did not make reasonable inquiries of the predecessor auditor, they did not learn that the predecessor auditor had sought further evidence concerning the purported acquisition. While conducting the audit for 1993, Respondents learned that the predecessor auditor had concerns about the valuation and ownership of the mortgage notes receivable going back to the 1992 financial statements. Also, during their 1993 audit, Respondents became aware that the mortgage notes were in default and that Madison Group had referred the notes to a third party for collection. Notwithstanding learning these facts, Respondents did not perform any audit procedures during the 1993 audit to substantiate the valuation of the notes. Respondents only obtained representations from management that collection efforts were being made. However, under GAAS, representations from management cannot substitute for the application of auditing procedures necessary to afford a reasonable basis for the opinion on the financial statements. SAS No. 19, "Client Representations", 1977, codified as AU Section 333A.02. c. Respondents failed to qualify or disclaim an opinion on the financial statements. Respondents did not adhere to the GAAS standards of reporting when they rendered unqualified audit reports without having formed such opinions on the basis of a GAAS audit. SAS No. 58, "Reports on Audited Financial Statements", 1988, codified as AU Section 508.31, states that if the auditor has not obtained sufficient competent evidential matter to support management's assertions about the nature of a matter involving an uncertainty and its presentation or disclosure in the financial statements, he should consider the need to express a qualified opinion or to disclaim an opinion because of a scope limitation. Respondents failed to verify the appropriate value of the media assets and any impairment of that amount before rendering the audit reports. Respondents, additionally, failed to obtain sufficient competent evidential matter to support the valuation and ownership rights of the mortgage notes receivable, which Madison Group did not own. In both years, Respondents issued reports that contained unqualified opinions as to the conformity of the financial statements with GAAP. The reports also contained supplementary "explanatory" paragraphs. The explanatory paragraph in the 1992 report stated that the company was in the process of developing plans to generate revenues from its media products, and that there was no assurance of its ability to market the products. The explanatory paragraph in the 1993 report repeated the above statements, disclosed that the mortgage note receivable was in default, referred to the company's significant negative working capital, and disclosed that the company was in default on various notes. It concluded that there would be substantial doubt about the company's ability to continue as a going concern if it were unable to generate revenues from its media products, realize proceeds from the mortgage note receivable, or reach agreement with its creditors and obtain other sources of financing. However, by not qualifying their audit reports as to GAAP, Respondents enabled Madison Group to report assets that were materially overstated or worthless. Auditors may not substitute such reservations in their reports for determining appropriate asset valuations. D. LEGAL ANALYSIS Respondents Engaged in Improper Professional Conduct for Purposes of Rule 102(e) of the Commission's Rules of Practice. The audits performed by Respondents of Madison Group's 1992 and 1993 financial statements did not meet applicable GAAS standards, nor did the financial statements reflect the proper application of GAAP. Respondents failed to comply with the first standard and third standards of field work, which require them to adequately plan the audit and to obtain sufficient competent evidential matter through inspection, observation, inquiries, and confirmations to afford a reasonable basis for their opinion regarding the financial statements of the Company. SAS No. 1, Section 150, "Generally Accepted Auditing Standards", 1972, codified as AU Section 150.02. Rather than plan the engagement and execute audit procedures with the professional skepticism necessary to obtain more persuasive evidence sufficient to support Madison Group's reported assets, Respondents based their audit reports principally on unreasonable and unsubstantiated estimates of the fair value of Madison Group's principal assets by independent appraisers and on the uncorroborated representations of Madison Group's management regarding the mortgage notes receivable. Oral or written representations from management are not a substitute for the application of those auditing procedures necessary to afford a reasonable basis for an opinion on the financial statements. SAS No. 19, "Client Representations", 1977, codified as AU Section 333.02. Moreover, Respondents should not have accepted the appraisers' valuations because the assumptions used by the appraisers clearly were inappropriate in that Madison Group did not have the financial wherewithal to support the assumptions. Respondents engaged in improper professional conduct because they rendered unqualified audit reports without having formed their opinions on the basis of audits conducted in accordance with GAAS. SAS No. 58, codified as AU Section 508.17. While Respondents reported the existence of the substantial uncertainties existing in respect of the company's ability to realize its principal reported assets in explanatory paragraphs in their audit reports, and while the company's own disclosures revealed its inability, absent changed circumstances, to recover or realize the carrying value of these assets, these disclosures were not sufficient. Respondents should either have utilized additional procedures to determine the appropriate carrying values of the assets, including the extent of any impairment, before they opined on the financial statements, or, failing satisfactory additional audit evidence, should not have rendered unqualified reports. IV. Based upon the foregoing, the Commission deems it appropriate and in the public interest to accept the Offers of Settlement submitted by the Respondents and accordingly, IT IS HEREBY ORDERED, effective immediately, that: 1. Respondents Miguel A. Cabrera, Jr. and M.A. Cabrera & Co., P.A. are denied the privilege of appearing or practicing before the Commission as accountants. 2. Three years from the date of this Order, Miguel A. Cabrera, Jr. orM.A. Cabrera & Co., P.A. may apply to the Commission by submitting an application to the Office of the Chief Accountant which requests that he or they be permitted to resume appearing or practicing before the Commission as: a. a preparer or reviewer, or a person responsible for the preparation or review, of financial statements of a public company to be filed with the Commission upon submission of an application satisfactory to the Commission in which he undertakes that, in his practice before the Commission, his work will be reviewed by the independent audit committee of the company for which he works or in some other manner acceptable to the Commission; b. an independent accountant upon submission of an application containing a showing satisfactory to the Commission that: (1.) Miguel A. Cabrera, Jr. or M.A. Cabrera & Co., P.A., or any firm with which Miguel A. Cabrera, Jr. is or becomes associated in any capacity, is and will remain a member of the SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms ("SEC Practice Section") as long as he or they appear or practice before the Commission as independent accountants; (2.) Miguel A. Cabrera, Jr. or the firm has received an unqualified report relating to his or the firm's most recent peer review conducted in accordance with the guidelines adopted by the SEC Practice Section; and (3.) Miguel A. Cabrera, Jr. or the firm will comply with all applicable SEC Practice Section requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education, as long as he or they appear or practice before the Commission as independent accountants. c. The Commission's review of any request or application by Respondents to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Respondents' character, integrity, professional conduct, or qualifications to appear or practice before the Commission. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: Rule 102(e) of the Commission's Rules of Practice provides, in pertinent part, that the Commission may deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission: "... (ii) to be lacking in character or integrity or to have engaged in unethical or improper professional conduct..." [2]: The financial statements showed negative working capital of $1.5 million as of September 30, 1992 and $2.3 million at September 30, 1993. Madison Group showed a loss of $868,000 in fiscal year 1992 and $3.1 million in fiscal year 1993, and only nominal operating revenues. [3]: Moreover, shortly after commencing the audit of Madison Group's 1992 financial statements, the predecessor auditor resigned because, among other things, he could not obtain sufficient evidence to support the appraised value of the media assets acquired in 1991 and 1992. [4]: In January 1995, Madison Group determined that it had, in prior periods, improperly accounted for the media assets at their appraised fair values and restated its 1992 and 1993 financial statements in its 1994 Form 10-K filed with the Commission to correct for "...errors in the application of accounting principles." Madison Group restated the carrying amount of media assets from $30.1 million to $1.4 million as of September 30, 1992. [5]: Madison Group also restated its 1992 and 1993 financial statements to eliminate the mortgage notes receivable from its balance sheets. The Company described the restatements in the Form 10-K as the "...correction of an error resulting from oversight in the use of facts in recording the acquisition of the notes." [6]: The predecessor auditor resigned on January 12, 1993, shortly after commencing his audit of Madison Group's financial statements as of September 30, 1992 and for the year then ended. Cabrera & Co. was engaged by Madison Group on or about January 25, 1993 to audit the Company's fiscal year 1992 financial statements.