==========================================START OF PAGE 1====== UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Exchange Act of 1934 Release No. 37738 / September 27, 1996 Accounting and Auditing Enforcement Release No. 828 / September 27, 1996 Administrative Proceeding File No. 3-9108 ------------------------------- : In the Matter of : ORDER INSTITUTING PUBLIC : ADMINISTRATIVE PROCEEDINGS FREDERICK W. SMITH, C.P.A., : AND OPINION AND ORDER PURSUANT : TO RULE 102(e) OF THE Respondent : COMMISSION'S RULES OF PRACTICE : : ------------------------------- I. The Commission deems it appropriate and in the public interest to institute administrative proceedings against Frederick W. Smith, C.P.A. ("Smith"), pursuant to Rule 102(e)(1) of the Commission's Rules of Practice. 1/ Accordingly, IT IS HEREBY ORDERED that said proceedings be, and hereby are, instituted. Simultaneously with the institution of these proceedings, Smith has submitted an Offer of Settlement ("Offer") solely for the purpose of this public administrative proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice, 17 C.F.R.  201.100 et seq. 1/ Rule 102(e)(1), 17 C.F.R.  201.102(e)(1), of the Commission's Rules of Practice provides in relevant part: 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 after notice of and opportunity for hearing in the matter . . . (ii) to be lacking in character or integrity or to have engaged in unethical or improper professional conduct . . . . In his Offer, which the Commission has determined to accept, Smith consents, without admitting or denying any of the findings set forth herein, except that he admits jurisdiction of the Commission over him and jurisdiction over the matters set forth in this proceeding, to the entry of this Order Instituting Public Administrative Proceedings and Opinion and Order pursuant to Rule 102(e) of the Commission's Rules of Practice ("Order"). II. FINDINGS On the basis of this Order and the Respondent's Offer, the Commission finds 2/ that: A. The Respondent Smith is 50 years old and resides in Boca Raton, Florida. He is a sole practitioner and has been licensed in Florida as a certified public accountant ("CPA") since 1991. Smith rendered an unqualified audit opinion with respect to the financial statements of Mobile Services International Corporation ("Mobile" ) for its fiscal year ended December 31, 1993. B. Entity Involved Mobile is a Delaware corporation located, at all relevant times, in Boca Raton, Florida. Mobile was in the business of providing mobile telecommunications services as an alternative to cellular telephone service. In 1992, Mobile became registered with the Commission under Section 12(g) of the Securities Exchange Act of 1934. The company's stock trades on the National Association of Securities Dealers' bulletin board. C. Background In April 1993, Mobile acquired certain assets, namely franchise and directorship rights ("franchise rights"), which had been granted by the franchisor to develop mobile telecommunications systems in California and South Florida. Pursuant to the franchise agreement, Mobile as the franchisee, was entirely dependent upon the franchisor, to assist it in the sale, development and servicing of the mobile systems by providing: (1) proprietary "know-how" and trade secrets relating to the design and operation of the mobile systems; (2) training in the management and operation of the business; and (3) counselling and guidance in the maintenance of the business. The continued existence of the franchisor was essential to Mobile's 2/ The findings herein are made pursuant to Respondent Smith's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding. ==========================================START OF PAGE 2====== ability to develop and market the systems under the franchise agreement. The franchisor's role was so vital that, if it were to become defunct, the franchise rights would be essentially worthless. Mobile envisioned operating and marketing the mobile telecommunications systems for use primarily by small businesses and fleets as a low-cost alternative to cellular telephone systems. The company maintained that under its system, customers' calls could originate or be placed anywhere in the world with long distance charges billed by the carrier of the customer's choice, similar to cellular systems. Mobile had allegedly planned to offer its mobile communications systems as "turnkey" telecommunications packages which included mobile phones, digital pagers and voice mail systems all linked together with the same telephone number. On or about April 26, 1994, Mobile filed with the Commission a Form 10-KSB for the fiscal year ended December 31, 1993 which contained false and misleading information concerning the franchise rights. In this filing, Mobile reported the franchise rights on its financial statements as an asset of approximately $4.6 million which represented approximately 80 percent of the company's total reported assets. At the time of the filing of this periodic report, however, the franchise rights were worthless because the franchisor was defunct. In fact, the franchisor had ceased all operations and was out of business since July 1993. Consequently, the franchise rights were permanently impaired resulting in a loss of any future economic benefit to Mobile. D. Smith's Auditing Failures Smith audited Mobile's financial statements for the fiscal year ended December 31, 1993. Smith's audit report included an unqualified opinion with respect to Mobile's financial statements for fiscal 1993. Smith's report, dated April 6, 1994, represented that the financial statements had been audited in accordance with generally accepted auditing standards ("GAAS") and presented fairly, in all material respects, the financial position of Mobile as of December 31, 1993, in conformity with generally accepted accounting principles ("GAAP"). Smith's audit opinion was included in Mobile's Form 10-KSB. Contrary to Smith's representation, the financial statements contained in Mobile's filings with the Commission were not presented in conformity with GAAP because they materially overstated the franchise rights and were not audited in accordance with GAAS because: (1) Smith lacked sufficient competent evidence to afford a reasonable basis for his opinion regarding the financial statements; and (2) Smith did not ==========================================START OF PAGE 3====== exercise due professional care in performing the audit. Therefore, Smith engaged in improper professional conduct within the meaning of Rule 102(e). ==========================================START OF PAGE 4====== 1. Failure to Obtain Sufficient Competent Evidential Matter One of the GAAS standards of field work provides that "[s]ufficient competent evidential matter ... be obtained through inspection, observation, inquiries and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit." Codification of Statements on Auditing Standards ("AU")  150.02. Most of an auditor's work in forming an opinion on financial statements consists of obtaining and evaluating evidential matter concerning the assertions (representations by management) in such financial statements. AU  326.02. One of the principal assertions of management that the auditor should evaluate is whether the assets are properly valued in the company's financial statements. AU  326.07. Under GAAS, "evidential matter" supporting the financial statements is defined as "the underlying accounting data and all corroborating information available to the auditor." AU  326.14. Corroborating information includes "documentary material such as checks, invoices, contracts, and minutes of meetings; confirmations and other written representations by knowledgeable people; information obtained by the auditor from inquiry, observation, inspection, and physical examination; and other information developed by, or available to, the auditor which permits him to reach conclusions through valid reasoning." AU  326.16. Therefore, by itself, accounting data cannot be considered sufficient support for financial statements. AU  326.15. In accordance with GAAS, Smith was required to obtain corroborating evidential matter to support Mobile's valuation of the franchise rights as a $4.6 million asset (80 percent of total reported assets). This he failed to do. Smith's workpapers do not include any documentation that competent evidential matter was sought or obtained to support his opinion that the franchise rights were fairly stated. The only evidence of any audit work performed with regard to the franchise rights is a worksheet containing Smith's mathematical recalculations on which he arrived at the valuation figure. In these calculations, Smith failed to test the initial valuation of the franchise rights, or give any consideration to the possible impairment of the asset. Moreover, the only evidence obtained by Smith to purportedly support the existence of the franchisor is a memorandum provided to him by Mobile's management which predates both the collapse of the franchisor and the acquisition of the franchise rights. During his December 31, 1993 audit, Smith became aware that management was ostensibly considering a re-valuation of the franchise rights because of "difficulties at the franchisor." Minutes of a Mobile's board meetings which were included in Smith's workpapers, indicated the possible need for a re- ==========================================START OF PAGE 5====== evaluation of the franchise rights in that the franchisor's "survival was in question." As a follow-up to those board meetings, Smith received written correspondence from Mobile's management ostensibly asking him to look into a re-valuation of the franchise rights. Yet, despite all of this, Smith made no real attempt to determine the status of the franchisor during his December 31, 1993 audit. He never attempted to make any inquiries to the franchisor directly or to any of its former officers. Nor did he contact or attempt to contact any outside sources with regard to the franchisor or the franchise rights. Had Smith obtained sufficient competent evidential matter, he would have determined that the franchisor had been defunct since July 1993, and as a result would have concluded that the franchise rights had been grossly overstated on Mobile's financial statements. 2. Failure to Exercise Due Professional Care One of the general standards of auditing provides that "[d]ue professional care is to be exercised in the performance of the audit and the preparation of the report." AU  150.02. Due professional care imposes a responsibility upon the auditor to observe the standards of field work and reporting prescribed by GAAS. AU  230.02. As described above, Smith failed to exercise due professional care in the performance of his audit of Mobile's December 31, 1993 financial statements by failing to obtain sufficient competent evidential matter to corroborate the valuation of the franchise rights as a $4.6 million asset. Smith was required to document in the workpapers the auditing procedures applied and the audit evidence obtained which provided sufficient competent evidential matter to afford a reasonable basis for his opinion. AU  339.05c. The audit workpapers do not document a reasonable basis for Smith's opinion. III. ORDER IMPOSING SANCTIONS Based on the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by the Respondent and accordingly, IT IS HEREBY ORDERED, effective immediately, that: A. Smith is denied the privilege of appearing or practicing before the Commission as an independent accountant. B. Three (3) years from the date of this Order, Smith may apply to the Commission to resume appearing or practicing before the Commission as an independent accountant upon submission of an application to the Office of the Chief Accountant of the Commission containing a showing satisfactory to ==========================================START OF PAGE 6====== the Commission that: 1. Smith, or any firm with which he 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 practices before the Commission as an independent accountant; 2. Smith, or any firm with which he is or becomes associated in any capacity, 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. Smith, or any firm with which he is or becomes associated in any capacity, 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 appears or practices before the Commission as an independent accountant. C. The Commission's review of any request or application by Smith to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Smith's character, integrity, professional conduct, or qualifications to appear or practice before the Commission. By the Commission. Jonathan G. Katz Secretary ==========================================START OF PAGE 7======