UNITED STATES OF AMERICA
|In the Matter of
THOMAS J. SCANLON, C.P.A.
|ORDER INSTITUTING PUBLIC
PURSUANT TO SECTION 21C OF THE
SECURITIES EXCHANGE ACT OF
1934, MAKING FINDINGS, AND
The Securities and Exchange Commission (Commission) deems it appropriate to institute public administrative proceedings pursuant to Section 21C of the Securities Exchange Act of 1934 (Exchange Act) against Thomas J. Scanlon (Scanlon or Respondent).
In anticipation of the institution of these administrative proceedings, Respondent has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commissions jurisdiction over him and the subject matter of the proceeding, which are admitted, Respondent consents to the entry of this Order Instituting Public Administrative Proceedings Pursuant to Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing Cease-And-Desist Order (Order).
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 Respondents Offer of Settlement (Offer), the Commission makes the following findings:1
Scanlon was the concurring partner on the 1991 and 1992 audits of the consolidated financial statements of W.R. Grace & Co. (Grace) and was the engagement partner on the 1995 audit. Scanlon began his employment with Price Waterhouse LLP (PW) in 1964 and became a partner in 1976. (PW merged with Coopers & Lybrand L.L.P. on July 1, 1998 to form PricewaterhouseCoopers LLP.) Scanlon is a certified public accountant.
a) Grace was a New York corporation which had its principal executive offices in Boca Raton, Florida during at least a portion of 1991 through 1996. Graces primary businesses during this period were packaging, specialty chemicals and health care services. Graces securities are currently registered with the Commission pursuant to Section 12(b) of the Exchange Act and its common stock is listed for trading on the New York Stock Exchange. Grace has a December 31 fiscal year end.
b) During the period 1991 through 1993 and 1995 through 1996 (relating to fiscal years 1991, 1992 and 1995) (the relevant period), National Medical Care, Inc. (NMC) was Graces main health care subsidiary, with its headquarters in Waltham, Massachusetts. NMC provided kidney dialysis and home health services and manufactured specialized medical products. NMC comprised the majority of Graces Health Care Group, which group was, through the first quarter of 1995, one of Graces core businesses and was reported as a segment in Graces consolidated financial statements. The Health Care Group contributed a significant portion of the consolidated pretax earnings of Grace during the majority of the relevant period.
a) During the relevant period, Grace misstated the earnings of the Health Care Group by maintaining at NMC reserves which were not for any probable and reasonably estimable exposures, and which were, therefore, not recorded in conformity with Generally Accepted Accounting Principles (GAAP), specifically, Statement of Financial Accounting Standards No. 5 (FAS 5), Accounting for Contingencies. PW audited the consolidated financial statements of Grace during the relevant period. During the relevant period, Respondent was either the PW concurring partner or engagement partner responsible for those audits. Respondent was aware of the purpose of the reserves and, by failing to take the actions described below, was a cause of Graces violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
b) During the relevant period, the PW audit team, with Scanlon acting as the concurring partner for fiscal years 1991 and 1992, and as the audit partner for fiscal year 1995 (the Grace audit team), performed audits of Graces consolidated financial statements and issued audit reports containing unqualified opinions thereon. These financial statements were included in the Forms 10-K filed with the Commission by Grace for fiscal years 1991, 1992 and 1995. The audit reports stated that PW had conducted audits of Graces consolidated financial statements in accordance with generally accepted auditing standards (GAAS) and opined that Graces consolidated financial statements were fairly presented in conformity with GAAP.
4. EXCESS RESERVES AT NMC
a) The Grace audit team, including Scanlon as concurring partner, became aware during the 1991 audit that Grace and NMC had deferred reporting income at NMC for the purpose of bringing the earnings of the Health Care Group in line with targeted estimates. NMC deferred reporting income by increasing or establishing reserves (the excess reserves) which were not for any probable and reasonably estimable exposures, and which were, therefore, not recorded in conformity with GAAP, specifically, FAS 5.
b) During the relevant period, the amount of the excess reserves ranged from over $7 million to over $50 million.
c) During the 1991 audit, the Grace audit team, with the knowledge of Scanlon, proposed an adjustment to eliminate the excess reserves from Graces consolidated financial statements, as well as other adjustments. Grace management declined to record those adjustments. Scanlon concurred with the conclusion that the proposed adjustments, which included those related to the excess reserves, were not material to Graces consolidated financial statements taken as a whole, and thus not required to be recorded in Graces 1991 consolidated financial statements for those statements to be fairly presented in conformity with GAAP.
d) During fiscal year 1992, the Grace audit team, with the knowledge of Scanlon, had conversations with Grace management regarding the level of the excess reserves. In a meeting held in the fourth quarter of 1992, the Grace chief financial officer (the Grace CFO) informed the Grace audit team, including Scanlon, that (a) NMC expected to again defer income in 1992; (b) the income growth at NMC would slow from its current 30% level; and (c) a reduction of the excess reserves would help smooth the anticipated decline in growth. The Grace CFO was informed by the Grace audit team, including Scanlon, that PW had posted the 1991 income deferral to PWs schedule of proposed adjustments and that future increases or decreases in the excess reserves would result in proposed adjustments. The Grace CFO then discussed the possibility that the 1992 deferral could be used to cover other exposures. The Grace audit team, including Scanlon, agreed to monitor the situation. The income deferral for 1992 was not used to cover any other exposures.
e) During the 1992 audit, the Grace audit team, with the knowledge of Scanlon, again proposed an adjustment to eliminate the excess reserves from Graces 1992 consolidated financial statements, as well as other adjustments. Grace management declined to record those adjustments. Scanlon concurred with the conclusion that the proposed adjustments, which included those related to the excess reserves, were not material to Graces consolidated financial statements taken as a whole, and thus not required to be recorded in Graces 1992 consolidated financial statements for those statements to be fairly presented in conformity with GAAP.
f) At meetings held in January 1993 between members of the Grace audit team and Grace financial and senior management, including the Grace chief executive officer, the Grace audit team restated PWs conclusion that the excess reserves were not in conformity with GAAP. The Grace audit team obtained an agreement from Grace financial and senior management that the excess reserves would not increase in 1993, and that the reserves already established would be returned to income in the near future (which the Grace audit team defined as over the next several years) in a manner that would not distort materially Graces consolidated financial statements. This method of correcting the reserve misstatement was not in conformity with GAAP.
g) In the second quarter of 1995, Graces Board of Directors decided to dispose of NMC in a spin-off transaction. As a result, the Health Care Group was reported as a discontinued operation in Graces consolidated financial statements at June 30, 1995.
h) Grace reversed the excess reserves in their entirety from its financial statements in the fourth quarter of 1995. Grace improperly combined the reversal with other charges and adjustments associated with discontinuing the Health Care Group operations. Grace falsely described the reversal of the excess reserves in the Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of its Form 10-K for 1995 as a change in accounting estimate. In fact, the excess reserves had never been an estimate of anything and, therefore, had not been recorded in conformity with GAAP.
i) Scanlon received and reviewed drafts of Graces 1995 Form 10-K prior to its filing which included the above quoted inaccurate MD&A description.
5. AUDITS OF GRACES FINANCIAL STATEMENTS FOR 1991 - 1992 and 1995
a) Scanlon failed to comply with Statement on Auditing Standards No. 53, The Auditors Responsibility to Detect and Report Errors and Irregularities, (since superseded by SAS 82, Consideration of Fraud in a Financial Statement Audit) in that, as concurring partner, he should have identified the excess reserves as an irregularity and, as such, he should have (a) obtained assurance that the Audit Committee knew of the purpose of the excess reserves, and (b) insisted as a prerequisite to the issuance of an unqualified audit report, that Grace eliminate the excess reserves without regard to other possible audit adjustments to Graces financial statements.
b) As concurring partner, Scanlon also failed to insist on compliance with Statement on Auditing Standards No. 21, Segment Information in that the inclusion of the excess reserves in the Health Care Group segment information for the period 1991 through 1992 resulted in a material misstatement of segment information which, in turn, was material to Graces consolidated financial statements taken as a whole for one or more periods during the relevant period.
c) The excess reserves resulted in a distortion of the income growth trend of Graces Health Care Group. During the relevant period, Graces reported income growth rate for its Health Care Group did not accurately reflect the actual income growth rate.
d) Scanlon also failed to comply with Statement on Auditing Standards No. 8, Other Information in Documents Containing Audited Financial Statements in that he failed to take appropriate action relating to material misstatements of fact contained in the MD&A section of Graces 1991, 1992 and 1995 Forms 10-K relating to the disclosures regarding earnings and an assessment of the Health Care Group.
e) As a result of the failure to comply with the foregoing auditing standards, the audit reports on Graces consolidated financial statements included in Graces Forms 10-K for fiscal years 1991, 1992 and 1995 misstated that the audits were conducted in accordance with GAAS.
6. GRACES VIOLATIONS
Section 13(a) of the Exchange Act requires issuers such as Grace to file periodic reports with the Commission containing information prescribed by specific Commission rules. Such reports must be complete and accurate. Rules 13a-1 and 13a-13 require, respectively, the filing of Forms 10-K and 10-Q. Rule 12b-20 requires, in addition to information required in periodic reports by Commission rules, such further material information as may be necessary to make the required statements not misleading.
Grace, at all times relevant, was subject to the reporting requirements of Section 13(a) of the Exchange Act and the rules promulgated thereunder. The requirement that reports be filed includes the requirement that they be accurate and that financial statements be presented in conformity with GAAP. Grace violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 by filing Forms 10-K and 10-Q that contained material misrepresentations and omissions concerning the Health Care Groups and Grace's income and results of operations.
Section 13(b)(2)(A) of the Exchange Act requires certain issuers such as Grace to "make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer." Section 13(b)(2)(B) requires certain issuers such as Grace to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that transactions are booked accurately in a manner designed to permit the preparation of financial statements in conformity with GAAP. As described above, Grace failed to maintain accurate books and records and failed to maintain an adequate system of internal accounting controls, in violation of Sections 13(b)(2)(A) and 13(b)(2)(B).
Based on the foregoing, the Commission finds that Scanlon was a cause of Graces violations of Sections 13(a) and 13(b)(2) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
Accordingly, the Commission hereby accepts Respondents Offer of Settlement and orders that Respondent cease and desist from causing any violation and any future violation of Sections 13(a) and 13(b) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
By the Commission.
Jonathan G. Katz
|1||The findings herein are made pursuant to the Respondents Offer and are not binding on any other person or entity in this or any other proceeding.|
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