UNITED STATES OF AMERICA
In the Matter of
PETER D. STEWART, C.A.,
|ORDER INSTITUTING PUBLIC ADMINISTRATIVE PROCEEDINGS PURSUANT TO RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS|
The Commission deems it appropriate that public administrative proceedings pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice1 be, and hereby are, instituted against Peter D. Stewart ("Stewart"), John L. Harbor ("Harbor"), and David Chopping ("Chopping") (collectively the "Respondents").
In anticipation of the institution of this proceeding, Stewart, Harbor, and Chopping have each submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, Respondents consent to the entry of this Order Instituting Public Administrative Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings, and Imposing Remedial Sanctions ("Order"), and the entry of findings and imposition of remedial sanctions herein, without admitting or denying the findings herein, except that the Respondents admit the jurisdiction of the Commission over them and the subject matter of this proceeding.
The Commission makes the following findings.2
A. RESPONDENTS, OTHER RELEVANT ENTITIES AND INDIVIDUAL
Peter D. Stewart ("Stewart"), age 45, is a Chartered Accountant (C.A.) licensed by the Institute of Chartered Accountants of England and Wales.3 Stewart is a member of Moore Stephens Chartered Accountants ("Moore Stephens U.K.") and was the audit engagement partner for the audit of The Cronos Group's ("Cronos" or "the company") consolidated financial statements for the fiscal year ended December 31, 1996.
John L. Harbor ("Harbor"), age 55, is a Chartered Accountant licensed by the Institute of Chartered Accountants of England and Wales. He is a member of Moore Stephens U.K., headed the business group within the firm, and was the client liaison partner for the audit of Cronos' consolidated financial statements for the year ended December 31, 1996.
David Chopping ("Chopping"), age 38, is a Chartered Accountant licensed by the Institute of Chartered Accountants of England and Wales. He is a member of Moore Stephens and was the second partner for the audit of Cronos' consolidated financial statements for the year ended December 31, 1996.
2. Other Relevant Entities and Individual
The Cronos Group ("Cronos"), one of the ten largest lessors of marine cargo containers, is a Luxembourg holding company with its operational headquarters in San Francisco, California. Until 1999, Cronos' operational office was in Orchard Lea, England. Cronos' common stock is registered with the Commission pursuant to Section 12(g) of the Securities Exchange Act of 1934 ("Exchange Act") and is traded on the Nasdaq market system. From December 1995 through March 1999, Cronos was a "foreign private issuer" as defined by Exchange Act Rule 3b-4.
Stefan M. Palatin ("Palatin") is the former Chairman and CEO of the Cronos Group. In May 1997, Austrian authorities filed criminal fraud charges against Palatin. Subsequently, in July 1997, Palatin resigned his position as chairman and CEO of Cronos.
Contrin Holding S.A. ("Contrin") is a company founded by a former director of Cronos and business partner of Palatin. It evolved into a group of companies which organized and managed the equivalent of limited partnerships in Austria to finance, acquire and lease shipping containers to or through container leasing companies. In 1991, Palatin agreed to purchase Contrin and other entities in an installment agreement.
Barton Holdings Ltd. ("Barton") is a Bahamian bearer share company incorporated in January 1992. All evidence indicates that Palatin controlled Barton and, directly or indirectly, owned it. When Contrin became a potential liability for Palatin, he transferred ownership of Contrin to Barton.
Arthur Andersen (U.K.) ("Andersen") provided auditing services to Cronos from prior to the Company's IPO in 1995 through its resignation from the Cronos engagement on February 3, 1997. On the same day, Andersen sent a report pursuant to Section 10A of the Exchange Act to the Cronos board of directors.
Moore Stephens Chartered Accountants (U.K.) ("Moore Stephens UK") succeeded Andersen as Cronos' independent auditor. Moore Stephens UK provided auditing services to Cronos from March 1997 through August 1999. The firm is a member of Moore Stephens International.
Moore Stephens P.C. (NJ) ("Moore Stephens NJ") is a public accounting firm with offices in New Jersey and New York. The firm is a member of Moore Stephens International.
Stewart, Harbor, and Chopping, chartered accountants residing in the United Kingdom, engaged in improper professional conduct in connection with the audit of Cronos' financial statements for the year ended December 31, 1996. In March 1997, Moore Stephens UK became the auditors of Cronos after Andersen resigned when it failed to receive sufficient competent audit evidence to support a $1.5 million disbursement by the company, was denied access to the results of a corporate investigation involving other related party transactions, and Cronos' board refused to investigate the $1.5 million payment, forged and false confirmations, and other related party transactions.4 After contacting the company, Harbor conducted the client acceptance procedures, including contacting Andersen, the prior auditor, and learned the issues that caused Andersen to resign. In meetings with Palatin, Harbor was given a different explanation for the auditor's resignation, one that had nothing to do with the payment, forgeries or related party transactions. Nevertheless, after consulting with Chopping and others at Moore Stephens UK, Harbor chose to accept Palatin's representations and accepted the audit engagement. Stewart supervised the audit of Cronos' 1996 consolidated financial statements which reported total revenues of $169 million, Harbor acted as the client liaison partner, and Chopping consulted on, and reviewed, the audit procedures as second partner.
During the course of the audit, Stewart did not question Palatin's representations with respect to the $1.5 million disbursement, a subsequently attempted disbursement of $2 million, and a forged document that stated that the $1.5 million had been repaid in mid-January 1997. Nor did he examine Palatin's use of the forged document and false representations to secure a loan of $3.7 million from the company. A portion of the proceeds of this loan was used to repay the $1.5 million. Even though these events raised management integrity issues, Stewart's audit team decided to "audit around" the $1.5 million disbursement and other issues that gave rise to the resignation of their predecessor. The audit failed to address these issues as well as other problems that arose late in the audit related to collateral Palatin had pledged to secure a loan he obtained from Cronos.
Stewart chose to accept management's representations in spite of overwhelming conflicting evidence he learned from Andersen and other third parties. He disregarded advice provided by Moore Stephens NJ to examine these issues further, and he failed to comply with generally accepted auditing standards ("GAAS"). He failed to obtain sufficient competent evidential matter, exercise due professional care and appropriate professional skepticism, and to adequately plan the audit. Harbor and Chopping failed to comply with GAAS because they knew the issues concerning management integrity and related party transactions that gave rise to Andersen's resignation from the audit yet they approved the plan to "audit around" the issues and they approved the final unqualified audit report on Cronos' 1996 consolidated financial statements that were included in Cronos' Form 20-F filed with the Commission.
a. Misappropriation and False Representations
Palatin had repeatedly misappropriated funds from Cronos for years, beginning at least as early as 1994, before the company's initial public offering ("IPO"). By the time of the IPO, he had obtained more than $10 million, either by directing the company to make loans to Barton, a purportedly independent company that was a shareholder of Cronos but which, in fact, was a nominee for Palatin, or by intercepting and converting to his own use payments between Cronos and Contrin, a group of Austrian companies controlled, directly or indirectly, by Palatin. Through various means he concealed his frauds and avoided detection. Following the IPO, however, senior officials at Cronos and the company's auditor, Andersen, began to raise questions about Palatin's activities.
In the IPO at the end of 1995, Barton was identified as a selling shareholder and the proceeds from the sale of its shares were applied to reduce its indebtedness to the company. Nevertheless, at year-end, the company's financial statements reflected a receivable from Barton in the amount of $4.7 million. During the 1995 audit, Andersen sought evidence that the receivable was collectible, either in the form of financial statements from Barton or a third party guarantee of the debt. When Barton failed to respond, Andersen advised Palatin that the company would need to write down the receivable. Instead, Palatin agreed to personally guarantee the loan balance and he collateralized the guarantee by pledging shares of Cronos purportedly owned by one of his personal holding companies. Unknown to the company and Andersen, the shares were already pledged and held in escrow to secure a loan he owed to a third party. In effect, Palatin pledged shares he did not own. At the time, Andersen believed that Palatin gave the guarantee so he and the company could avoid the embarrassment and potential liability that would likely result from writing down a material asset shortly after the IPO. Several months later, Barton defaulted on the loan and Palatin, in effect, assumed the loan and negotiated an extension of the due date.
b. Growing Concerns
Several events occurred in the Spring of 1996 that caused company management and Andersen to question Palatin's integrity and his relationships with Barton, Contrin and Cronos. A receiver was appointed for certain of the Contrin entities in Austria and he began questioning several of the transactions with Cronos in connection with which Palatin had intercepted and converted payments. The receiver advised Cronos management that he believed the payments Contrin owed Cronos had been made to Cronos and, in some instances, cited evidence that the payments had been made directly to Palatin. He also asserted that payments purportedly made by Cronos to Contrin had never been received. While company employees followed up on these claims, an article appeared in the Austrian press that contained unsubstantiated allegations that Palatin had, in effect, controlled and looted Contrin and that he owned and controlled Barton. When the Cronos managers learned of these allegations, they recognized that they raised serious issues concerning the company's financial statements and related party disclosures as well as questions concerning Palatin's integrity.
In response, the general counsel, the chief financial officer and several other employee/directors of Cronos attempted to retain independent, outside counsel on behalf of the company to investigate the allegations. When they advised Palatin of their recommendation, he argued that an investigation was not necessary and he stripped the employees of their board seats. To quell pressure from Andersen and the senior employees, Palatin ultimately agreed to an investigation but insisted that the company's securities counsel conduct it. After engaging the firm, he fired the company's general counsel.
Counsel's investigation reportedly was hampered by a number of factors. It appears that they obtained little or no information from Austria, Switzerland (where, among other things, Barton purportedly maintained it's headquarters) or the Bahamas (where it was incorporated). Palatin denied the press allegations and the claims of Contrin's receiver but he provided little information and no substantive assistance to the investigators. According to the testimony of those who had first-hand knowledge of the report, its findings were inconclusive and it left unresolved the issues that gave rise to the investigation. Immediately after reporting to the board in early fall, 1996, the outside firm that conducted the investigation resigned as company counsel. Palatin thereafter refused to provide the report to Andersen despite the firm's repeated request for a copy.
c. Further Misappropriation
During the Summer of 1996, while counsel's investigation was underway, Palatin began exploring the possible sale of the company or his holdings, which constituted the majority of its outstanding shares. Talks progressed into the fall. The company retained an investment bank and agreed to the standard contingent fee arrangement common to these types of transactions. The investment bank neither required nor requested that the company escrow fees in connection with its services.
Nevertheless, in late October, Palatin directed company employees to transfer $1.5 million dollars to a non-company bank account. Palatin represented to employees that the purpose of the transfer was to escrow an investment banking fee and that the investment bank had requested the escrow. Both statements were false. In fact, the account was maintained in the name of Palatin's wife and one of his Panamanian, bearer-share companies at a NatWest Bank branch located in a suburb of London. Immediately after the funds were received into the account, a portion was disbursed to pay Palatin's personal expenses and most of the balance was withdrawn as cash.
d. Stonewalling, False Pretenses and Forgery
Shortly after the company transferred the funds to the account, the CFO questioned the payment and brought it to the attention of Andersen. Andersen, which was already uncomfortable because of the allegations regarding Barton and Contrin that gave rise to the investigation and the refusal of Cronos to provide it with the results of the investigation, attempted to examine the transaction as part of its year-end audit. Palatin refused to assist the auditors. When asked to provide details of the account in which the funds were deposited and verification of the whereabouts of the funds, Palatin refused but provided inconsistent and contradictory information concerning the nature of the account and the identity of the purported trustee. Thereafter, conflict mounted between the auditors and Palatin. As tensions increased, two of the company's three independent directors resigned. Andersen and Palatin ended the year virtually at a standoff over the issue.
In early 1997, Palatin directed the chief operating officer ("COO") to transfer an additional $2 million to the same NatWest account to which the October payment had been transferred, and he again claimed the purpose of the transfer was to escrow investment banking fees. Because the controversy with Andersen surrounding the $1.5 million transfer had not yet been resolved, the COO insisted that a disinterested board member approve the transfer. Palatin then produced a signed authorization from a board member who was a long-time friend and business associate. The document appeared to be a forgery. The general counsel and the CFO advised Andersen of the matter and a teleconference was held among Andersen, outside counsel, the general counsel and other company executives and board members. They agreed not to pay the funds unless the investment bankers confirmed that the funds were due and owing. Palatin responded by firing the CFO and general counsel, and demoting the COO.
Days later, several board members requested Palatin's assurance that the $1.5 million would be returned to the company. Palatin promised that the funds would be returned on January 13. When the funds were not returned on the 13th, Palatin explained that they were held in a time deposit and could not be released earlier than the 20th. He subsequently contradicted that statement by promising that they would be returned on the 16th.
On January 16, the board met in New York to consider, among other things, the repayment of the $1.5 million. Late in the meeting, Palatin produced to the board a forged facsimile letter, purportedly from NatWest, which stated that the funds had been returned to the company. The board relied on the document and concluded that the growing controversy had been resolved.
After the board meeting broke up and the sole independent director had left, Palatin unexpectedly reconvened the meeting and requested that the company loan him up to $4 million. The remaining three directors approved the loan. On January 21, Palatin drew $3.7 million against the loan. Several days later, he deposited $1.55 million of the proceeds into the NatWest account and directed the bank to forward it to Cronos. However, the funds were not credited to the Cronos account until the 29th, in part because the bank had learned in the meantime of the forged letter and was conducting its own investigation of the matter. Palatin, unaware of the bank's delay and assuming that the funds would be deposited to the company's account by the time his message arrived, sent a letter to Andersen on January 22 confirming that Cronos had received the $1.5 million. In fact, the company had not.
e. Andersen Responds, the Board Doesn't and Andersen Resigns
Meanwhile, on January 21, Andersen sought to verify the authenticity of the January 16 fax letter from NatWest and confirm that the funds had been transferred to the company. NatWest advised the auditors that the letter was a forgery and that the $1.5 million had not been transferred to the company. Andersen subsequently received Palatin's letter of the 22nd that represented that the funds had been received, and when they followed up to confirm the representation, learned again that Palatin's representations were not accurate.
Meanwhile, in early January, Andersen had begun corresponding with the company and the board concerning its inability to audit the $1.5 million and the requested $2 million payment, in part because it had not received adequate support for the two transactions. It advised the company of its reporting obligations pursuant to Section 10A of the Exchange Act unless it obtained the information it sought or the board instituted appropriate remedial action. The firm requested a meeting with the board. It received no response to this letter.
Andersen wrote again on January 13 and requested that the audit partner be permitted to attend the board meeting scheduled for the 16th. Again, it received no response. On January 24, after learning of the forged NatWest confirmation letter and the false representations in Palatin's letter of the 22nd that the money had been received, Andersen sent another letter to the board citing its earlier letters, the forged NatWest letter and the misrepresentation contained in the letter of the 22nd. Andersen requested that the board undertake an investigation of the $1.5 million payment and all related party transactions of prior years and that it provide a copy of the Counsel's investigation report. Andersen cautioned that if it did not receive an adequate response by January 28, it would take appropriate steps pursuant to Section 10A of the Exchange Act, including resignation from the engagement. On the 28th the board responded, stating that since the $1.5 million had been returned to the company, no further investigation was warranted. Palatin reiterated this position to Andersen on the 31st. On February 3, 1997, Andersen resigned as auditor and provided the company the report required by Section 10A of the Exchange Act. On the same day, the sole remaining independent director resigned from the board.
2. Cronos Retains Moore Stephens UK to Complete the Audit
After Andersen resigned the engagement, Cronos approached the other big five accounting firms and several regional accounting firms, all of whom rejected the engagement. Moore Stephens U.K. learned of the potential engagement from the company's Luxembourg attorney. Harbor contacted Cronos to inquire about the potential engagement. In his initial meeting with the company, Palatin and the company's COO told him that Andersen resigned due to personality conflicts between Andersen's audit personnel and Cronos' senior management. They explained that Andersen had used the $1.5 million payment issue as a pretext to terminate its relationship with Cronos. Palatin told Harbor that after the $1.5 million was returned to the company, Andersen continued to insist on auditing the transaction and would not consider the issue resolved. He contended that, in his view, Andersen had overstepped its authority as auditor and interfered with management of the company's operations. Palatin told Harbor that Andersen resigned when management rejected this interference and refused to do as Andersen requested.
After meeting with Cronos, Harbor met with the Andersen audit staff to obtain a clearance letter5 and to discuss issues with respect to the 1996 audit. At this meeting the Andersen personnel told Harbor that Andersen resigned the engagement because Cronos' board and management had not taken remedial measures with respect to several issues, the most important concerning audit support for the $1.5 million disbursement in October 1996. Andersen explained the issues that gave rise to its resignation including its concerns regarding forged documents, Palatin's misrepresentations, and related party transactions in general. Andersen also provided Harbor with copies of its January correspondence to Cronos.
Following the meeting, Moore Stephens UK requested that Andersen confirm in writing that it was not aware of any professional reasons why it should not accept the Cronos engagement. Andersen issued a qualified clearance letter to Moore Stephens UK whereby it referenced its January 1997 correspondence and Section 10A report as setting forth the reasons for its resignation from the Cronos engagement. Moore Stephens UK lacked experience with
U. S. reporting companies so it sought advice from other members of Moore Stephens International Network with experience in auditing listed companies, including Moore Stephens NJ. Members of the U.S. firms cautioned Harbor to further investigate the conflicting reasons for Andersen's resignation. Harbor did not do so. Instead, Moore Stephens UK accepted the Cronos engagement notwithstanding the qualified clearance letter from Andersen, evidence of a possible management defalcation with respect to the $1.5 million, the forged confirmation Palatin presented to the board, other evidence of false statements by Cronos' management, and advice from Moore Stephens NJ to further investigate the $1.5 million "escrow" payment. Stewart was named engagement partner and Chopping was made second partner on the engagement.6 Harbor and others at Moore Stephens UK essentially chose to believe Palatin's version of Andersen's resignation and related events over Andersen's explanation when Moore Stephens UK accepted the engagement.
3. The 1996 Cronos Audit Was Not Conducted in Accordance with GAAS
a. Failure to Examine Related Party Transactions
i. October 1996 Disbursement of $1.5 Million
Moore Stephens UK's audit plan called for enhanced audit procedures. However, these heightened procedures did not address the issues which Andersen raised and had caused it to resign. Stewart's examination of the $1.5 million payment was limited to contacting NatWest, the Thames Valley Police, the company's lawyers and Cronos management. NatWest officials confirmed again that the confirmation was a forgery and that the matter was under investigation. Stewart did not pursue the matter further and did not send a confirmation letter to NatWest to determine whether the funds were in the account at year-end nor did he seek the identity of the account holder. The Thames Valley Police confirmed that the matter was under investigation. The audit team learned that the company's attorneys had not found any additional information with respect to the false confirmation. Stewart did not seek further evidence regarding the account from NatWest, Palatin, the company, or any other source.
Palatin and his attorney, who was also a board member, insisted that the matter was closed because the funds had been returned to Cronos and they directed Moore Stephens UK away from further inquiry into the matter. Palatin belatedly claimed that he had guaranteed the funds back in October and directed that the company could account for the transaction at year-end as a receivable from a related party. In the end, Stewart accepted the accounting treatment and he decided to "audit around" the $1.5 million transaction. Moreover, he did not object when the company, in a footnote disclosure to the financial statements, represented that the funds had been held in an escrow account at year-end and subsequently returned to the company, although he had no evidence, other than Palatin's representations, that the statement was true and, in fact, he had substantial evidence that it was false.
He accepted the financial statement treatment despite Moore Stephens NJ's advice that GAAS required him to examine the $1.5 million transaction further. Moore Stephens NJ advised Stewart to contact the investment bankers, who advised Cronos on the proposed strategic alliance, to confirm the fee arrangement between the investment bankers and Cronos. Stewart did not do so.
Stewart also failed to examine the circumstances surrounding the forged confirmation and the repayment of the funds despite evidence that Palatin had provided a forged document to obtain a new loan which he used, in part, to repay the $1.5 million to the company. Stewart knew that the status of the $1.5 million payment was a central issue at the board meeting of January 16th. He also knew that Palatin produced a forged confirmation at the meeting to demonstrate that the funds had been returned. Finally, unlike Andersen, he knew that the board subsequently approved a $4 million loan to Palatin, an amount curiously similar to the aggregate value of the October payment and the attempted January disbursement. Finally, he knew that the $1.5 million was not, in fact, repaid until after the loan had been disbursed. Stewart failed to examine these events to determine whether they were connected. In doing so, he avoided the obvious.
ii. Ignoring Contrin's Allegations
The 1996 audit also did not adequately examine the claims by Contrin and the contingent liability they raised. Stewart did not contact Cronos' Austrian counsel concerning the ongoing arbitration between the company and Contrin to determine the nature and extent of any contingent liability that might result from Contrin's claims. Instead, he relied on the oral representation of Palatin's personal attorney that the matter was in arbitration and not material. As a consequence, he did not learn the details of Contrin's claims against Cronos and what they implied about Palatin's integrity and veracity. The information Stewart learned from Andersen about these matters was sufficient to put him on notice that serious issues of liability, integrity and veracity were raised by Contrin's claims.
iii. Failure to Examine the Palatin/Barton Relationship
The 1996 audit failed to examine the loan transactions with Barton and Palatin's assumption of responsibility for Barton's debt. The Barton loans and the transactions whereby Palatin guaranteed and ultimately assumed responsibility for the loans were discussed extensively in the footnotes to the company's 1996 financial statements and consequently were within the scope of the audit. In addition, these transactions and questions concerning the relationship between Palatin and Barton were factors in Andersen's decision to resign the engagement and file a report pursuant to Section 10A of the Exchange Act. Stewart and others at Moore Stephens U.K. were aware of the issues, they knew that the Barton loan payments had been disbursed directly to Palatin's bank accounts, they knew of the public allegations that Palatin controlled Barton, and Stewart knew that Counsel's investigation of the issue was inconclusive. He also knew that the counsel had resigned immediately after making its report to the board. It was obvious that the matter raised not only disclosure issues but, more significantly, issues of management integrity and the audit team's ability to rely on management representations. Moore Stephens NJ recognized the significance of the issue and urged Stewart to inquire further into the matter. Rather than follow the guidance of the GAAS experts from the U.S. member firm and require further information from Palatin, Stewart relied on Palatin's false oral assurances that he was not associated with Barton and had assumed its loan based on his own sense of moral obligation.
iv. Failure to Examine Evidence of Asset Impairment
In July of 1997, before Cronos filed its annual report on Form 20-F, Harbor and
Stewart learned facts that put them on notice that Palatin did not have clear title to the shares he had pledged as collateral when he guaranteed and later assumed the Barton loan. They learned that the shares were subject to a prior sales agreement and were being held by a trustee who refused to transfer them. Because the trustee, as well as the other party to the sales agreement, were directors of the company, the auditors had the opportunity to make inquiries of all parties to determine whether the company's related party disclosures in the footnotes to its financial statements were correct and to satisfy themselves about the related management integrity issues that were raised by the prospect that the chairman and CEO of the company had pledged collateral he did not own to secure his debt to the company. Stewart made no inquiries concerning these issues. Instead, he wrongly concluded, without sufficient basis in fact, that the collateral available was sufficient to secure all of Palatin's obligations to the company and he authorized his firm to issue an unqualified audit report on the company's financial statements.
D. LEGAL ANALYSIS
Rule 2-02(b)(1) of Regulation S-X requires an auditor's report to state "whether the audit was made in accordance with GAAS.7 Accountants are required to conduct audits in accordance with GAAS, including the general standards, standards of field work, and standards of reporting. These standards require, among other things, that an auditor exercise due professional care and maintain appropriate professional skepticism in the conduct of the examination of the financial statements and preparation of the report8; that the audit be adequately planned9; that the auditor obtain sufficient competent evidence to afford a reasonable basis for an opinion regarding the financial statements under audit10; and that the report state whether the financial statements are presented in conformity with generally accepted accounting principles ("GAAP") and contain an expression of opinion regarding the financial statements taken as a whole.11
GAAS provides that "the auditor should be aware of the possible existence of material related party transactions that could affect the financial statements."12 The applicable section provides guidance on procedures that should be considered by the auditor, when he is performing an examination of financial statements in accordance with GAAS, to identify related party relationships and transactions and to satisfy himself concerning the required financial statement accounting and disclosure. Stewart did not comply with this provision. In spite of overwhelming evidence that related party transactions had not been accurately disclosed, and that issues of management integrity were implicated, Stewart chose to "audit around" the issues. However, the provision requires that related party issues be addressed, not avoided. Stewart thereby failed to comply with the requirements of GAAS.
Further, GAAP required that Cronos disclose the impairment of the collateral that Palatin had pledged to secure a loan from the company.13 When Harbor learned of the potential impairment of this collateral, he did not review the financial statements and the resulting footnote disclosure concerning the issue. Any competent auditor who had done so would have realized that they did not comply with GAAP. Similarly, Chopping did not comply with GAAS in performing his second partner review of Cronos' 1996 audit with respect to the procedures and disclosure concerning this collateral. Even a cursory review of the working papers would have revealed that Stewart had not reviewed any appropriate documentation concerning the validity of the pledge or Palatin's right to pledge the collateral.
Stewart, as the engagement partner on the audit, had overall responsibility with respect to the audit of Cronos' 1996 financial statements. He knew the planning procedures used in the audit and the results obtained through the application of the procedures. The procedures were not adequate in light of the information he received from the company's management, advice from Moore Stephens NJ, and information obtained from third parties. He chose to ignore advice concerning the requirements under GAAS with respect to related party transactions and impairment of collateral Palatin had pledged to secure a loan from the company.
Harbor, as the client liaison partner, attended the initial meetings with the company's management and Andersen. He then communicated this information to Stewart and later reviewed Stewart's work. He knew the qualifications contained in Andersen's clearance letter and the issues Andersen raised in its Section 10A report to the Commission. He knew of the concerns regarding related party transactions, management integrity, and the impairment of the collateral. In his review of Stewart's work, Harbor failed to address the audit team's failure to audit the $1.5 million disbursement, issues concerning other related party transactions, and the impairment of the collateral. Accordingly, he too failed to comply with the requirements of GAAS.
Chopping, as the second partner on the audit, acted as a backstop to Stewart. Although he did not have day-to-day involvement in the audit, Chopping nonetheless was consulted prior to Moore Stephens UK's acceptance of the Cronos engagement, the audit team conferred with him during the course of the audit, and he reviewed the overall audit as second partner. Chopping also had knowledge of the management integrity and related party transaction issues raised by Andersen in its resignation from the Cronos engagement. Yet, he chose to accept Stewart's decision to "audit around" the $1.5 million disbursement and the forged bank confirmation. Thus, he also failed to comply with the requirements of GAAS.
Under these circumstances, Harbor, Stewart and Chopping engaged in improper professional conduct in connection with Moore Stephens UK's audit of Cronos' 1996 financial statements. Specifically, Harbor's, Stewart's and Chopping's conduct consisted of: (1) failing to exercise due professional care and sufficient professional skepticism in the performance of the audit, as required by GAAS; (2) failing to adequately plan the audit, as required by GAAS; (3) failing to ensure that sufficient competent evidential matter was obtained to afford a reasonable basis for the conclusions with respect to the audit issues discussed herein, as required by GAAS; and (4) improperly issuing an audit report opining that Cronos' financial statements were presented in conformity with GAAP and that its audits were conducted in accordance with GAAS when they were not.
Based on the foregoing, the Commission finds that Stewart, Harbor and Chopping engaged in improper professional conduct pursuant to Rule 102(e) of the Commission's Rules of Practice.
Based on the foregoing, the Commission deems it appropriate to accept Respondents' Offers, and to impose the sanctions agreed to therein. Accordingly,
IT IS HEREBY ORDERED, effective immediately, that:
A. Stewart is denied the privilege of appearing or practicing before the Commission as an accountant.
B. After one year from the date of this Order, Stewart may request that the Commission consider his reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as:
1. a preparer or reviewer, or a person responsible for the preparation or review, of any public company's financial statements that are filed with the Commission. Such application must satisfy the Commission that Stewart's work in his practice before the Commission will be reviewed either by the independent audit committee of the public company for which he works or in some other acceptable manner, as long as he practices before the Commission in this capacity; and/or
2. an independent accountant. Such application must satisfy the Commission that:
(a) Stewart, or the firm with which he is associated, is a member of the SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms (SEC Practice Section) or an equivalent British organization that includes or is supplemented by peer review, concurring partner review, continuing professional education and other membership requirements that provide appropriate quality controls over an accounting and auditing practice, as long as he practices before the Commission as an independent accountant;
(b) Stewart, 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 or equivalent organization; and
(c) as long as Stewart appears or practices before the Commission as an independent accountant he will remain either a member of or associated with a member firm of the SEC Practice Section or equivalent British organization and will comply with all applicable SEC Practice Section or equivalent British organization requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education.
C. The Commission's review of any request or application by Stewart to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Stewart's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
D. Harbor and Chopping are censured pursuant to Rule 102(e) of the Commission's Rules of Practice for the conduct described herein and each undertakes that:
1.he, or any firm with which he is or becomes associated in any capacity, will remain either a member of or associated with a member firm of the SEC Practice Section or the equivalent British organization as long as he appears or practices before the Commission as an independent accountant,
2.he will comply with all applicable SEC Practice Section or equivalent British organization requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education, as long as he appears or practices before the Commission as an independent accountant .
By the Commission
Jonathan G. Katz
|1||Rule 102(e)(1)(ii), provides in relevant part, that: the Commission may deny, temporarily or permanently, the privilege of appearing or practicing before it any person who is found to have engaged in improper professional conduct.|
|2||The findings herein are made pursuant to Respondents' Offers and are not binding on any other person or entity in this or any other proceeding.|
|3||In Britain, a C.A. is the professional equivalent of a Certified Public Accountant in the United States.|
|4||For a more complete description of these events and related proceedings involving Cronos and former executives and directors of the company see In the Matter of The Cronos Group, Admin. Proc. No. 3-10096 (Nov. 15, 1999); In the Matter of Axel E. Friedberg and Rudolf J. Weissenberger, Admin. Proc. No. 3-10263 (August 8, 2000).|
|5||GAAS requires that an auditor communicate with a predecessor auditor prior to the acceptance of the engagement to determine whether there are prior client-auditor problems that might cause the successor auditor to refuse the engagement. See Codification of Statements on Auditing Standards (hereinafter "AU") § 315. The successor auditor generally requests the predecessor auditor to confirm in writing that there are no concerns that require the successor auditor to not accept the engagement. The return communication of such a request is sometimes referred to as a clearance letter.|
|6||Chopping was selected based on several factors, including his position as senior technical partner at the firm, his knowledge of auditing standards in major jurisdictions and the fact that he was the editor of a manual on UK GAAP, produced by the Institute of Chartered Accountants.|
|7||17 CFR § 210.2-02(b)(1).|
|8|| AU §§ 150.02; 230.01; 230.07; 333.02.
|9||AU §§ 150.02; 311.03.|
|10||AU §§ 150.02; 326.01.|
|11||AU §§ 150.02; 410; 411; 508.20.|
|12||AU § 334.|
|13||Item 9 of Form 20-F requires a registrant to describe, among other things, internal and external sources of liquidity and events and uncertainties that may result in material changes in the registrant's liquidity. Palatin's misstatements concerning the collateral as well as his technical default of the sales agreement associated with the pledged collateral raised an uncertainty regarding recoverability of the loan to Palatin.|
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