UNITED STATES OF AMERICA
|In the Matter of
GERALD R. HINSHAW, CPA,
|ORDER INSTITUTING PROCEEDINGS
PURSUANT TO RULE 102(e) OF THE
COMMISSION'S RULES OF PRACTICE,
MAKING FINDINGS AND IMPOSING
The Securities and Exchange 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 Gerald R. Hinshaw, CPA.
Accordingly, IT IS HEREBY ORDERED that said proceedings be, and hereby are, instituted.
Gerald R. Hinshaw ("Hinshaw" or "Respondent") has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. 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, and prior to a hearing pursuant to the Commis-sion's Rules of Practice, 17 C.F.R. § 201.1 et seq., and without admitting or denying any of the findings herein, except as to the Commission's jurisdiction, over him and the subject matter of these proceedings, which Hinshaw admits, Hinshaw consents to the entry of this Order Instituting Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings and Imposing Remedial Sanctions ("Order").
On the basis of this Order and Hinshaw's Offer of Settlement, the Commission finds that:
Gerald R. Hinshaw, is a certified public accountant licensed in the States of Illinois and Michigan. 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 of American Telephone + Data, Inc.'s ("AT+D" or "the Company") financial statements.
On May 3, 1993, AT+D, then a public shell company with little or no assets, acquired through a reverse merger three private companies: Com-puters for the Physically Handicapped - Telecommunications ("CPH-T"); Electronic Townhall Meetings; and Fedfax, Inc. 2 On June 9, 1993, AT+D filed a Form 8-K with the Commission, containing "proforma financial statements" on a consolidated basis for the years ended December 31, 1992, 1991, and 1990 ("the 1993 Form 8-K"). The 1993 Form 8-K was accompanied by Hinshaw's audit report dated, May 28, 1993. On July 28, 1993, the Company filed an amended Form 8-K filed with the Commission ("the Amended Form 8-K"). The Amended Form 8-K included financial statements, for the years ended December 31, 1992, 1991, and 1990, of each of the acquired entities and financial statements for AT+D as a shell corpor-ation. Each of the financial statements was accompanied by an audit report signed by Hinshaw.
In his reports, each of which contained unqualified opinions on the above described financial statements, Hinshaw stated that those financial statements were presented fairly in all material respects in conformity with generally accepted accounting principles ("GAAP"), and that his audits were conducted in accordance with generally accepted auditing standards ("GAAS"). As set forth below, however, AT+D's financial statements were not presented in conformity with GAAP because, (a) neither AT+D nor any of its subsidiaries owned certain of the reported assets during any of the relevant periods, and (b) Respondent did not conform to numerous GAAS requirements in the performance of his audits of the financial statements of AT+D and its three subsidiaries. 3
1. The 1993 Form 8-K
a. Licensing Rights
In its 1993 Form 8-K, AT+D reported as an asset, in its proforma financial statements, the right to license certain patents, covering high speed facsimile transmission systems, valued at $5 million ("the licensing rights"). The 1993 Form 8-K stated that in March 1992, CPH-T paid $5,000,000 in cash to Palawan Ltd., PLC for the exclusive North American rights to utilize the subject patents. In fact, Palawan was a fictitious entity, the patents and facsimile system did not exist, and the $5 million cash payment did not occur.
In his purported audit of AT+D's proforma financial statements filed with the 1993 Form 8-K, Hinshaw failed to take sufficient steps to determine the existence of the licensing rights or their value. For example, Hinshaw did not corroborate the purported $5 million cash payment by reviewing CPH-T's bank records. If Hinshaw had done so, he would have learned that CPH-T did not make the cash payment and did not have the financial resources to make such a payment.
b. Preferred Stock
In its 1993 Form 8-K, AT+D reported as an asset, in its proforma financial statements, 58,000 shares of the preferred stock of Greenway Environmental Services, Inc. ("Greenway"), which it valued at $5.8 million as of December 31, 1992. AT+D stated in that filing that this stock was contributed to CPH-T in November 1992. In fact, AT+D owned no interest in Greenway; the stock certificate held by CPH-T, dated April 21, 1993, was fabricated by AT+D management. Moreover, the shares of Greenway stock, even if owned by AT+D, had a value substantially less than the reported $5.8 million.4
Had Hinshaw properly reviewed the stock certificate held by AT+D, which was dated after the end of the reporting period, he would have learned that CPH-T did not own the Greenway preferred shares at the end of the reporting period. Had he followed reasonable audit procedures to ascertain the ownership and value of the 58,000 shares of Greenway stock claimed by AT+D, he would have learned that AT+D and its subsidiaries owned no interest in Greenway and that, in any event, such stock had a value substantially less than the reported $5.8 million.
2. The Amended Form 8-K
a. Licensing Rights
The Amended Form 8-K reported that AT+D held licensing rights with a purported value of $10 million for the years ended 1992, 1991 and 1990. In contrast to the 1993 Form 8-K, filed 49 days before, the Amended Form 8-K described the licensing rights as being acquired in March 1990 rather than March 1992. Moreover, in the Amended Form 8-K, the value of the licensing rights increased from $5 million to $10 million. This new valuation is explained in the financial statements as being due to: 1) a $5 million cash payment to Palawan; and 2) a future $5 million payment to Palawan. The Amended Form 8-K included financial statements for CPH-T and Fedfax, audited by Hinshaw, which each reported licensing rights valued at $5 million. As, stated above, however, neither Palawan, nor the assets purportedly acquired from it, existed.
In connection with his audits of the financial statements of CPH-T and Fedfax, included in the Amended Form 8-K, Hinshaw failed to take proper steps to determine whether the licensing rights existed and whether their carrying value was appropriate. Instead, he accepted the exis-tence and valuation of the licensing rights solely on the basis of management's representations.
b. Preferred Stock
The financial statements included in the Amended Form 8-K did not report the Greenway preferred stock as an asset. Instead, AT+D's acquisition of this asset is treated as a "subsequent event." The notes to the financial statements of CPH-T state that a principal of AT+D contrib-uted the Greenway preferred stock to CPH-T in April 1993.
Although the Greenway preferred shares were no longer reported by AT+D as an asset for the year ended December 31, 1992, in exercising professional skepti-cism, Hinshaw needed to obtain sufficient evidentiary matter to determine whether the change in AT+D's treatment of the Greenway transaction was the result of management error or fraud.5 He also needed to determine whether AT+D had, in fact, acquired the Greenway stock at any time. This he failed to do.
C. LEGAL ANALYSIS
Respondent Engaged in Improper Professional Conduct
The audits performed by the Respondent of financial statements filed with the Commission did not meet applicable GAAS standards, nor did the financial statements reflect the proper application of GAAP.6 Respondent failed to comply with the first and third standards of field work, which required him to adequately plan the audit and to obtain sufficient competent evidential matter through inspection, observation, inquiries, and confirmations to afford a reasonable basis for his 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 appropriately and obtain audit evidence sufficient to support AT+D's reported assets, Respondent based his audit reports principally on unreasonable, unsubstantiated and uncorroborated representations of AT+D's management. 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. Respondent should have utilized additional procedures to determine whether the assets existed and were indeed owned by AT+D, and, if so, the appropriate carrying values of the assets, before he opined on the financial statements.
In sum, Respondent engaged in improper professional conduct for the purposes of Rule 102(e)(ii) of the Commission's Rules of Practice, because he rendered unqualified reports on the financial statements of AT+D and its subsidiaries without having conducted his audits in accordance with GAAS. Also, the Respondent failed to determine or report that the financial statements did not conform to GAAP. His failure to follow basic audit procedures demonstrated a reckless disregard for the standards of his pro-fession.
Based upon the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by the Respondent and accordingly,
IT IS HEREBY ORDERED, effective immediately, that Respondent Gerald R. Hinshaw is denied the privilege of appearing or practicing before the Commission as an accountant.
IT IS FURTHER ORDERED, that Hinshaw comply with his undertaking to, on reasonable notice and without service of a subpoena, provide discovery and testify truthfully at any deposition and at any judicial or administrative proceeding arising from or relating to the matters described in this Order.
By the Commission.
Jonathan G. Katz
|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||AT+D was originally incorporated in Delaware under the name Direct Investments, Inc. On May 10, 1993, the name of the company was changed to American Telephone + Data. Therefore, at the time of the three acquisitions, the Company was still named Direct Investments, Inc.|
|3||It is difficult to evaluate the audits conducted by Hinshaw because he did not create any audit working papers to support the audits described in this Order, as required by SAS No. 41, "Working Papers," as codified by AU Section 339. Hence, it is uncertain what audit procedures, if any, he conducted. His failure to properly document his audit work is an additional GAAS violation.|
|4||In its June 1994 10-Q, AT+D admitted that the Greenway stock was valueless.|
|5||SAS No. 53 as amended by SAS No. 82, "Consideration of Fraud in a Financial Statement Audit," codified as AU 316.27, states that due professional care requires an auditor to exercise professional skepticism.|
|6||Although the June 1993 Form 8-K contained what were designated "pro forma financial statements," in his report Hinshaw stated that they conformed to GAAP and that he he had conducted an audit of those financial statements in accordance with GAAS.|
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