Initial Decision of an SEC Administrative Law Judge
In the Matter of
In the Matter of
HORTON & COMPANY
July 2, 2002
|APPEARANCES:||Thomas M. Melton and Alison J. Okinaka for the Division of Enforcement, Securities and Exchange Commission|
John J. Pribish and Adrienne Rogove of Saul Ewing LLP for Respondents Horton & Company and Edward C. Horton
|BEFORE:||Carol Fox Foelak, Administrative Law Judge|
This Initial Decision sanctions CPA Edward C. Horton and his firm Horton & Company in connection with their 1997 and 1998 audits of a now-defunct construction company that traded on the OTC Bulletin Board. The corporation's filings with the Commission included independent auditor reports from Horton and Horton & Company. They were not, however, independent because they had provided bookkeeping services and compiled the corporation's financial statements during the audit periods. Thus, they were auditing their own work. The Initial Decision denies them the privilege of appearing or practicing before the Commission for a period of one year.
The Securities and Exchange Commission (Commission) initiated this proceeding on October 31, 2000, by an Order Instituting Proceedings (OIP). The proceeding was authorized pursuant to Rule 102(e) of the Commission's Rules of Practice, 17 C.F.R. § 201.102(e) (Rule 102(e)).
The undersigned held four days of hearings in New York, New York, on April 23 through 26, 2001. The Division of Enforcement (Division) called five witnesses from whom testimony was taken, including Respondent Horton and two expert witnesses. Respondents called two witnesses from whom testimony was taken, including Respondent Horton and one expert witness. Forty-nine exhibits were admitted into evidence, thirty offered by the Division, and nineteen, by Respondents.1
The findings and conclusions in this Initial Decision are based on the record. Preponderance of the evidence was applied as the standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). Pursuant to the Administrative Procedure Act,2 the following post hearing pleadings were considered: (1) the Division's July 20, 2001, Proposed Findings of Fact and Conclusions of Law and Superceding Post-Trial Brief; (2) Respondents' August 7, 2001, Revised Proposed Findings of Fact and Conclusions of Law and Revised Post-Hearing Brief; (3) the Division's August 13, 2001, Reply Brief; and (4) Respondents' August 13, 2001, Reply Post-Hearing Brief. All arguments, proposed findings, and conclusions that are inconsistent with this Initial Decision were considered and rejected.
The OIP alleges that Respondents willfully aided and abetted violations of Section 13(a) of the Securities Exchange Act of 1934 (Exchange Act) and Rules 13a-1 and 13a-13 thereunder, and that they engaged in improper professional conduct during two audits of Iron Holdings Corporation (Iron Holdings), a publicly traded company, later known as Monarch Investment Properties, Inc. (Monarch).3 The financial statements audited by Respondents were included in the Forms 10-KSB the company filed with the Commission for periods ending June 30, 1997, and 1998 (1997 and 1998 Forms 10-KSB). The OIP alleges that the financial statements materially misrepresented the company's financial condition and its results of operations after Respondents failed to record, or require it to record, an expense related to stock options the company issued to consultants in 1997. Thus, the Division argues, the financial statements were not presented in accordance with Generally Accepted Accounting Principles (GAAP), in violation of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13.4
The OIP also charges that Respondents lacked independence with respect to the audits because they had made the bookkeeping entries for Iron Holdings during 1997 and 1998, and therefore audited their own work. Thus, the Division argues, Respondents' audits were not in accordance with Generally Accepted Auditing Standards (GAAS) because of their alleged lack of independence.5 The Division requests that Respondents be censured and denied the privilege of appearing or practicing before the Commission for at least two years.
Respondents argue that the Division failed to prove a primary violation of Exchange Act Section 13(a) or the additional elements of an aiding and abetting violation. They also argue that the Division failed to prove that they violated any law or professional standard during the 1997 and 1998 audits or that they were reckless during the audits.
Respondents argue that Horton properly accounted for the value of the options by considering the underlying condition of the company, as permitted by professional standards. They also argue that the Division failed to prove that they lacked independence in performing the audits, which were of the consolidated financial statements of the holding company Iron Holdings and its operating subsidiary Iron Eagle Contracting and Mechanical, Inc. (Iron Eagle). Although Respondents concede that they performed limited bookkeeping services for the parent, Iron Holdings, which had few transactions, they argue that they maintained their independence nevertheless.
Edward C. Horton has been a Certified Public Accountant (CPA) since 1980, and is currently licensed to practice in New Jersey, Massachusetts, and Florida; he is a member of the American Institute of Certified Public Accountants (AICPA) and its SEC Practice and Private Companies Practice Sections. Tr. 117, 440. He graduated from Rutgers University in 1978 with degrees in accounting and economics. Tr. 437. Then he started as a junior staff accountant at Fox & Company, a national accounting firm that later merged with Grant Thornton, and rose to a managerial position. His work included audits of public and non-public companies and manufacturing, service, and construction companies. Tr. 438-39. Horton left in 1985 to start Horton & Company. Tr. 438. At the time at issue, he was a partner and the managing director of Horton & Company. Tr. 115, 436.
Horton has had about 200 audit engagements during his career; about fifty were for public corporations that file reports with the Commission (SEC reporting companies). He is aware that there are more stringent requirements for audits of SEC reporting companies than for audits of private companies. Tr. 118-19.
At the time at issue Horton & Company provided accounting, auditing, tax, compilation, review, and consulting services. Tr. 437. Twenty-five to thirty-five percent of the firm's business was from SEC reporting companies. Tr. 439. Horton has been accepted as an expert in the area of business valuations by the Superior Court of the State of New Jersey, and the U.S. Bankruptcy Court. Tr. 440-41, 553.
Horton was the engagement partner on the 1997 and 1998 Iron Holdings audit engagements. Tr. 116-17. Tonya Pirone, an accountant at Horton & Company from 1992 to 1999, worked on the engagements under the supervision of Horton. Tr. 19-21, 41-61, 75-77, 126; Div. Exs. 29, 30, 34, 36, 37. Raymond Del Vecchio, a CPA and partner at Horton & Company during the time at issue, was the concurring reviewer on the audits. Tr. 100-04, 106-13.
On October 15, 2001, Horton joined the accounting firm of Citrin Cooperman & Company. Resp. Ex. 14. Horton & Company is inactive. Resp. Ex. 14.
Iron Holdings was created to become the public holding corporation for Iron Eagle. Tr. 120-21, 441-42. Iron Eagle was a contractor that bid on municipal contracts for construction of gas and water mains and other projects in the New York City area. Div. Ex. 87 at 6, Div. Ex. 88 at 5. It was transferred to Iron Holdings on October 3, 1996, by J.J.F.N. Services, Inc. (JJFN) in exchange for a note for $1.3 million, the amount that JJFN had invested in Iron Eagle.6 Tr. 375, 441-44; Div. Ex. 87 at 45. Then Iron Holdings was transformed into a public corporation via a reverse merger with a public shell in return for 500,000 shares of its 5 million shares of issued and outstanding stock.7 Tr. 546-47. Respondents had been JJFN's auditors, and, in turn, became Iron Holdings's auditors. Tr. 120, 441-42, 483.
During 1997 the officers and directors of Iron Holdings were Anthony Gurino, his brother, and another individual; Gurino was Chief Executive Officer, President, Secretary, and a Director. Div. Ex. 87 at 51-52. Subsequently, Gurino was the sole officer and director. Div. Ex. 88 at 52. Essentially, Iron Holdings had no employees except Gurino, who was Respondents' sole contact at the company. Tr. 64, 73-75, 129-32, 172-73, 493. Gurino owned a restaurant and a food store, but had no particular financial background. Tr. 30, 539-40; Div. Ex. 87 at 52; Div. Ex. 88 at 52-53.
Iron Holdings started trading in July 1997. Tr. 166-67, 512. The National Association of Securities Dealers approved it for trading on the Over the Counter Bulletin Board on June 26, 1997, at an initial price of $1.00 bid, $1.50 ask. Div. Ex. 87 at 16. The stock reached its high (bid) price of $7.00 in August. Tr. 512; Div. Ex. 88 at 16; Resp. Ex. 10. On September 29, the stock traded at $3.94 bid, $4.06 ask. Div. Ex. 87 at 16. It continued to move down, and was trading at twenty-five cents or less in June 1998. Tr. 512-13; Div. Ex. 88 at 16; Resp. Ex. 10. There was a one-for-ten reverse stock split on July 31, 1998.8 Div. Ex. 88 at 44. However, Iron Holdings soon went out of business as a result of Iron Eagle's ceasing operations in June 1998. Tr. 82, 117, 505; Div. Ex. 88 at 5-6.
Iron Holdings's consolidated financial statements in the 1997 Form 10-KSB showed a stockholders deficit of $65,566 and a history of losses, including net losses of $40,642 for the six months ended June 30, 1997, the period covered by the Form 10-KSB. Div. Ex. 87 at 27, 29. Financial statements in the 1998 Form 10-KSB showed a stockholders deficit of $1,277,864 and net losses of $2,211,746 for the year ended June 30, 1998. Div. Ex. 88 at 29, 31. Soon thereafter the company was defunct.
Iron Holdings issued 3.8 million stock options in April 1997.9 At that time, Iron Holdings had five million shares outstanding. Tr. 142. Iron Holdings stock did not trade on any market, the company had a history of operating losses, and its liabilities exceeded its assets.
On April 21, 1997, Iron Holdings issued options, exercisable for six months, to purchase 2.8 million shares of its stock to Anchor Capital Management, Ltd. (Anchor), a British West Indies corporation, at an exercise price of $1.50 per share (Anchor Options). Div. Ex. 87 at 8-9, 46, Div. Ex. 88 at 59. Anchor paid Iron Holdings $28,000 for the options. Div. Ex. 87 at 8-9, 46, Div. Ex. 88 at 59. The 1997 Form 10-KSB listed this amount on Iron Holdings's consolidated balance sheet as additional paid-in capital to stockholders' deficit. Div. Ex. 87 at 27. The 1997 Form 10-KSB represented that the $1.50 exercise price for the Anchor Options was determined "through arms length negotiations." Div. Ex. 87 at 9. Anchor exercised options to purchase 687,000 shares in August 1997; Iron Holdings received $1,030,500 in proceeds.10 Div. Ex. 87 at 47.
At the same time it awarded the Anchor Options, Iron Holdings awarded four consulting firms a total of one million options, exercisable for one year, to purchase its stock at an exercise price of $0.01 per share (Consulting Options).11 The options were in exchange for public relations services promoting Iron Holdings stock. All the options were exercised in July 1997, before Iron Holdings commenced trading; one million shares were issued for an exercise price totaling $10,000.12 Tr. 153; Div. Ex. 87 at 44, Div. Ex. 88 at 44. The Notes to Consolidated Financial Statements included in the 1997 and 1998 Forms 10-KSB disclose the Consulting Options, the option price, and the fact that they were exercised. Div. Ex. 87 at 44; Div. Ex. 88 at 44. The filings gave no value to the Consulting Options, and attributed no expense to them. Tr. 150-52; Div. Exs. 87, 88.
Iron Holdings did not employ anyone who could prepare its financial statements. Tr. 96, 130-32. During 1997 and 1998, Horton & Company prepared cash disbursements and receipts journals, the general ledger, income statements, and balance sheets for Iron Holdings; it compiled the unaudited financial statements included with Iron Holdings's Forms 10-QSB for the periods ending September 30 and December 31, 1997, and March 31, 1998. Pirone obtained check stubs and bank statements, and Gurino told her the purpose of the check or deposit; she entered the information into a software program; she reconciled bank statements, accrued any expenses that did not go through the bank statements, and consolidated Iron Eagle's and Iron Holdings's financial statements. Tr. 22-41, 57-59, 73-75, 78-79, 95-98, 136-38; Div. Ex. 37 at 1, Div. Exs. 92-95. Gurino decided what would be recorded as an expense, asset, or reduction in liability. Tr. 172-73. Respondents did not substitute their judgment for Gurino's. Tr. 74-75, 454-56.
Horton testified that he and Gurino discussed Gurino's representation that in the opinion of management, the options were properly accounted for in the financial statements. Tr. 456, 489; Resp. Exs. 3G, 9. There is no other evidence in the record bearing on whether, or how, Gurino affirmatively decided that the Consulting Options had no value and should give rise to no expense. The Division argues that Gurino lacked the financial acumen to value the Consulting Options himself and, therefore, Horton must have valued them while compiling the financial statements. The Division did not, however, call Gurino as a witness to testify whether, how, and on whose advice he valued the Consulting Options. There is no evidence in the record to controvert Horton's testimony that Gurino made the judgments, and in light of the Division's burden of proof, it is found that Respondents did not substitute their judgment for Gurino's.
Iron Holdings had little activity, about fifteen transactions each quarter, and it took Pirone one hour each quarter to review and reconcile its check stubs and deposit slips. Tr. 78-80, 86-88, 90; Resp. Exs. 2A, 2B, 3A. Iron Eagle employed a separate CPA firm to prepare its financial statements. Tr. 26, 63, 453, 494, 502-03. There is no issue in this proceeding concerning Respondents' audit of Iron Eagle, Iron Holdings's operating subsidiary, which accounted for the bulk of the financial activity in the consolidated operation. For the 1997 audit engagement, 95% of the work pertained to Iron Eagle. Tr. 494. That proportion was less for the 1998 audit because the operations of Iron Eagle were being discontinued. Tr. 502-05.
In planning the audits, Horton considered materiality and audit risk.13 He determined materiality to be $37,000 and $18,000, respectively, for the 1997 and 1998 audit engagements. Tr. 484-88. In evaluating the three components of audit risk as to Iron Holdings, he considered control risk to be high because the company had no internal controls. Tr. 54-55, 495; Div. Ex. 36 at 2. He considered inherent risk of a misstatement to be low because of the limited number of transactions and the fact that Gurino was involved in all of them. Tr. 495. He also considered detection risk to be low because Iron Holdings had a limited number of transactions, and Horton & Company was verifying them all. Tr. 495-96. The operating company, Iron Eagle, had hundreds of transactions a month, while Iron Holdings had a total of fifteen transactions during the first six months of 1997. Tr. 496-97. The 1997 audit engagement started in July and lasted about two months. Tr. 123.
Pirone consistently initialed the audit plan and the planning and review checklists to indicate that she had completed an item, but others at Horton and Company did not. Tr. 46, 53-54, 59-61, 81; Div. Exs. 29, 36, 37, 56. The Division argues that the absence in the work papers of initials and notes on various activities indicates that Respondents did not perform the activities. Such absence in itself, however, does not outweigh evidence that Respondents did perform activities, particularly in light of the Division's burden of proof.
Because of Iron Holdings's lack of internal controls, Horton & Company verified all significant transactions by confirmations or other means. Tr. 495-96, 502. Pirone sent out the confirmations, to be reviewed and returned by the outside parties to confirm, for example, the balance due on a loan. Tr. 20, 42-43, 55, 75-76, 128, 501. As to the options, Pirone's concern was to verify the cash that came in when they were exercised and to confirm share ownership with the stock transfer agent. Tr. 42-43, 49-52. Pirone did not send confirmations to the recipients of the Consulting Options, which had already been exercised at the time of the field work for the 1997 audit; she sent a confirmation to Anchor to confirm the option price, the exercise price, and the amount paid. Tr. 126, 128, 167-68; Div. Ex. 30. The Anchor Options were still open during the field work for the 1997 audit, and it was difficult to determine the exercise price by examining the Anchor subscription agreement. Tr. 167-68; Div. Ex. 61 at 1.
Del Vecchio performed a concurring review of the 1997 and 1998 financial statements. Tr. 106-13. The evidence that he did so outweighs the fact that his signature does not appear on the checklists for the audits. Tr. 108, 110; Div. Exs. 36, 56. Only Pirone was conscientious in initialing such papers. Tr. 46, 53-54, 59-61, 81; Div. Exs. 29, 36, 37, 56.
The 1997 Form 10-KSB, received in the Commission October 10, 1997, contained an Independent Auditors' Report of Horton & Company that stated that it had audited the accompanying consolidated financial statements in accordance with GAAS, and gave an unqualified opinion that the financial statements conformed with GAAP. Div. Ex. 87 at 24. Horton reviewed the Form 10-KSB before it was filed with the Commission. Tr. 136. Similarly, the 1998 Form 10-KSB, received in the Commission October 6, 1998, contained an Independent Auditors' Report of Horton & Company that stated that it had audited the accompanying consolidated financial statements in accordance with GAAS, and gave an unqualified opinion that the financial statements conformed with GAAP, with explanatory language concerning Iron Holdings's ability to continue as a going concern.14 Tr. 138-39; Div. Ex. 88 at 26.
The financial statements included in the 1997 and 1998 Forms 10-KSB gave no value to the Consulting Options, and attributed no expense to them. Tr. 150-51; Div. Exs. 87, 88. Horton's independent opinion accorded with this. Tr. 466-73, 489. Horton reviewed the Consulting Options agreements, which were retained in Respondents' files. Tr. 141-43. Neither Horton nor Pirone contacted the recipients of the Consulting Options regarding the services they were to provide. Tr. 50, 152. In assessing the valuation of the Consulting Options, Horton considered the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 123 (FAS 123). Tr. 155-57; Div. Ex. 76. He was aware that the Anchor Options could be the basis of a market approach to valuing Iron Holdings securities, using the Black-Scholes option-pricing model (Black-Scholes). Tr. 156-57, 160-69, 466-69; Div. Ex. 76. Horton was also aware that shortly before the options were issued, management parted with ten percent ownership of the company when 500,000 shares were paid to effect the business combination with the public shell, for no other value received. Tr. 468. Horton considered fundamental analysis, which FAS 123 permits, to be more appropriate than Black-Scholes for Iron Holdings. Tr. 466-67. Thus, he considered the facts of the company's accumulated deficit, its negative shareholders equity (liabilities exceeded assets), and its history of operating losses, as well as the fact that there was no market for the company's stock at the time the options were issued. Tr. 153-58, 466-73. Horton did not hire an expert to value the options or consult with anyone at the AICPA. Tr. 170.
Horton did not issue a going concern opinion in 1997 because the capital Iron Holdings raised from exercise of the options would enable it to survive for another year. Tr. 158-60, 500-01. An auditor must look at subsequent events that occur between the end of the reporting period and the date of the audit report, but Horton believed that an appraisal of fair market value of a business must be as of a point in time and cannot take into account subsequent events. Tr. 469-71, 500. Horton knew at the time of the 1997 audit that Iron Holdings had engaged in a public offering. Tr. 120-23.
Lawrence Levine testified as an expert witness for the Division and was accepted as an expert on valuation of options and on materiality. Tr. 336-46 (Qualifications), 348-415, 641-53 (Opinion); Div. Ex. 103. Robert J. Sack testified as an expert witness for the Division and was accepted as an expert on accounting of stock options, audit procedures regarding stock options, and auditor independence. Tr. 176-190 (Qualifications), 196-335 (Opinion); Div. Exs. 90, 104. Kenneth MacKenzie testified as an expert witness for Respondents and was accepted as an expert on the valuation of options. Tr. 558-65 (Qualifications), 565-622 (Opinion); Resp. Ex. 13.
As Division expert Levine opined, the Consulting Options should have been valued in light of the guidance provided in FAS 123, as Horton did. As Levine opined, it would be difficult to value directly the services to be received from the recipients of the Consulting Options, so that the fair value of the equity instruments involved should be measured instead. Horton did that, as well, using fundamental analysis. Levine, however, opined that the Black-Scholes was the best method for valuing the Consulting Options. Tr. 366-415; Div. Ex. 103.
There are three methodologies used to value a closely held firm - the income approach, the asset approach, and the market approach. Div. Ex. 103 at 1-2. Levine rejected the income and asset approaches - that is, analysis of Iron Holdings's fundamentals - because the company was unprofitable and its liabilities exceeded its assets, resulting in a stockholders deficit. Div. Ex. 103 at 4-5. In other words, the options would be valueless under these approaches, as Horton found. Black-Scholes is used in a market approach valuation, that is, valuing the company as established by the market place. Div. Ex. 103 at 5. Levine's Black-Scholes evaluation was based on the Anchor Options, taking into account the difference in expiration date and other factors. He acknowledged that because Iron Holdings stock was not traded on any market and paid no dividends, two of six variables in Black-Scholes were absent.16 Div. Ex. 103 at 5-6. Levine estimated the Consulting Options' value as $348,880.17 Div. Ex. 103 at 7.
Division expert Sack used Levine's valuation to opine on accounting for the Consulting Options. Their fair value should have been added to Iron Holdings's capital accounts with a corresponding increase in either an asset or a current period's expense account. Div. Ex. 104 at 7. Thus, Sack opined, current expense in 1997 would increase by the full amount if Iron Holdings received no probable future economic benefit in exchange for the options. If it obtained a probable future economic benefit from the consulting agreements, and thus created an asset, the asset would be amortized as a charge to expense from April 21, 1997, over the two-year life of the consulting agreements. Tr. 250; Div. Ex. 104 at 7-8. Thus pro-rated, the expense attributed to the six-month period ended June 30, 1997, would be about $35,000. Tr. 248-250; Div. Ex. 104 at 7-8. Pro-rated, the expense for the year 1998 would be $174,440. Div. Ex. 104 at 8.
Respondent expert MacKenzie opined that Iron Holdings's value on April 21, 1997, was zero or less. Tr. 583-85, 592. Among the negative factors that he considered, however, was his own previous related-party valuation of Iron Eagle's assets. Tr. 583-84. Concerning the market approach used by Levine, MacKenzie noted that the Anchor Options were a sample of one and opined that a sample of one was insufficient. Tr. 589-91.
Respondents were charged, pursuant to Rule 102(e)(1)(iii) of the Commission's Rules of Practice, 17 C.F.R. § 201.102(e)(1)(iii), with willfully aiding and abetting violations of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13, and, pursuant to Rule 102(e)(1)(ii), 17 C.F.R. § 201.102(e)(1)(ii), with improper professional conduct. These charges were based on Respondents' alleged lack of independence and on their alleged improper practices related to accounting for the Consulting Options.
In this section it is concluded that Respondents willfully aided and abetted violations by Iron Holdings of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13, and that they engaged in improper professional conduct because they lacked independence. It is also concluded that the charges related to the Consulting Options were not proved.
Rule 102(e)(1)(iii) provides for sanctions against accountants who "have willfully violated, or willfully aided and abetted the violation of any provision of the Federal securities laws or the rules and regulations thereunder." A finding of willfulness does not require an intent to violate, but merely an intent to do the act which constitutes a violation. See Wonsover v. SEC, 205 F.3d 408, 413-15 (D.C. Cir. 2000); see also Steadman v. SEC, 603 F.2d 1126, 1135 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981); Arthur Lipper Corp. v. SEC, 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965). Respondents are charged with willfully aiding and abetting violations of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13.
Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 require public corporations to file annual reports with the Commission. The requirement that reports be filed carries with it the obligation that those filings be accurate. See SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, Zimmerman v. SEC, 440 U.S. 913 (1979). As a "small business issuer" for the purpose of the disclosure requirements, Iron Holdings filed annual reports on Form 10-KSB. See 17 C.F.R. § 228.10(a)(1); see generally 17 C.F.R. §§ 228.10-.702 (Regulation S-B) (setting forth disclosure requirements for small business issuers).
As required by 17 C.F.R. § 228.310, financial statements included with Form 10-KSB must be prepared in accordance with GAAP and must be audited by an independent accountant. Pursuant to 17 C.F.R. § 228.310 Note 2, the report and qualifications of the independent accountant must comply with 17 C.F.R. § 210.2.18 See 17 C.F.R. §§ 210.2-01(b), (c) (defining independent accountant);19 17 C.F.R. § 210.2-02 (specifying requirements for accountants' reports, including a requirement to state whether the audit was made in accordance with GAAS).
For aiding and abetting liability under the federal securities laws, three elements must be established: (1) a primary or independent securities law violation committed by another party; (2) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; and (3) that the aider and abettor knowingly and substantially assisted the conduct that constitutes the violation. See Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Woods v. Barnett Bank, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); IIT v. Cornfield, 619 F.2d 909, 922 (2d Cir. 1980); Woodward v. Metro Bank, 522 F.2d 84, 94-97 (5th Cir. 1975); SEC v. Coffey, 493 F.2d 1304, 1316-17 (6th Cir. 1974); Russo Sec. Inc., 53 S.E.C. 271, 278 & n.16 (1997); Donald T. Sheldon, 51 S.E.C. 59, 66 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995); William R. Carter, 47 S.E.C. 471, 502-03 (1981). A person cannot escape aiding and abetting liability by claiming he was ignorant of the securities laws. See Sharon M. Graham, 53 S.E.C. 1072, 1084 n.33 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). The knowledge or awareness requirement can be satisfied by recklessness when the alleged aider and abettor is a fiduciary or active participant. See Ross v. Bolton, 904 F.2d 819, 824 (2d Cir. 1990); Cornfield, 619 F.2d at 923, 925; Rolf v. Blythe, Eastman Dillon & Co. Inc., 570 F.2d 38, 47-48 (2d Cir. 1978); Woodward, 522 F.2d at 97.
Horton & Company is accountable for the actions of its responsible officers, including Horton, who was a partner, managing director, and the engagement partner for the Iron Holdings audits. See C.E. Carlson, Inc. v. SEC, 859 F.2d 1429, 1435 (10th Cir. 1988); A.J. White & Co. v. SEC, 556 F.2d 619, 624 (1st Cir. 1977). A company's state of mind may be imputed from that of individuals controlling it. See SEC v. Blinder, Robinson & Co. Inc., 542 F. Supp. 468, 476 n.3 (D. Colo. 1982) (citing SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1096-97 nn.16-18 (2d Cir. 1972)).
The OIP charges Respondents with willfully aiding and abetting violations by Iron Holdings of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13. The OIP alleges that the financial statements filed with Iron Holdings's 1997 and 1998 Forms 10-KSB were not audited by an "independent public accountant" and were materially misleading in that they failed to record an expense associated with the Consulting Options as required by GAAP.
Iron Holdings violated Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 when it filed its 1997 and 1998 Forms 10-KSB because the financial statements filed with the forms were not audited by an "independent public accountant." Respondents lacked independence because, during 1997 and 1998, Horton & Company made the actual bookkeeping entries for Iron Holdings and prepared its cash journals, general ledger, balance sheet and income statement. It compiled the unaudited financial statements included with Iron Holdings's Forms 10-QSB for the periods ending September 30 and December 31, 1997, and March 31, 1998. The Commission has long held a strict position that an accounting firm is not independent within the meaning of Regulation S-X if it has provided bookkeeping services, including maintenance of basic accounting records and preparation of financial statements for a public corporation. The prohibition is predicated on independence concerns and not on materiality concerns. See Independence of Accountants, 46 Fed. Reg. 22569 (Apr. 20, 1981) (codified at 17 C.F.R. pt. 211).20 Thus, Respondents violated this prohibition by providing even minimal bookkeeping services to Iron Holdings.
The Division also argues that the Consulting Options were improperly accounted for so that Iron Holdings's financial statements were materially misleading, appearing less negative than they should have. This argument is based on the Division's contention that GAAP required that the financial statements account for the Consulting Options using Black-Scholes. The parties agree that FAS 123 is the relevant accounting standard. FAS 123 provides:
[a]ll transactions in which goods or services are the consideration received for the issuance of equity instruments shall be accounted for based on the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.
. . . [F]air value . . . is . . . the amount at which the asset could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Quoted market prices in active markets are the best evidence of fair value and shall be used as the basis for the measurement, if available. If quoted market prices are not available, the estimate of fair value shall be based on the best information available in the circumstances. The estimate of fair value shall consider prices for similar assets and the results of valuation techniques to the extent available in the circumstances. Examples of valuation techniques include the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved, option-pricing models, matrix pricing, option-adjusted spread models, and fundamental analysis.
FAS 123 at paras. 8-9 (quoting FAS 121 at para. 7). (emphasis added).
The Division notes that Respondents did not contact the recipients of the Consulting Options to determine the value of the services that they were to render, nor did they value the options by considering the Anchor Options and Black-Scholes. Thus, the Division argues, valuing the Consulting Options at zero and failing to record an expense attributed to them was not in conformity with GAAP. These facts do not show, however, that the accounting treatment of the Consulting Options was not in conformity with GAAP. It was impractical to value the consideration received for the Consulting Options, as the Division's valuation expert opined. Quoted market prices were not available. The Division's valuation expert opined that the Black-Scholes option-pricing model was the best method for valuing the Consulting Options; he conceded that fundamental analysis would value the Consulting Options at zero. Horton considered Black-Scholes but concluded that the Consulting Options were appropriately valued at zero using fundamental analysis.
In essence, the Division argues that the company's stock had value, as indicated by the payment for and exercise price of the Anchor Option. Respondents counter that the options had zero value because the company was fundamentally worthless. Both are correct. The company was fundamentally worthless, and the stock had value in the market place for a short period of time. Either approach is in conformity with GAAP since FAS 123 permits valuation based on fundamental analysis as well as valuation based on Black-Scholes. The auditing and accounting standards do not require an accountant who is confronted with more than one permissible approach to choose the method that most increases losses or liabilities. Thus, it is concluded that the financial statements included in the 1997 and 1998 Forms 10-KSB were not materially misleading in respect of the accounting treatment of the Consulting Options.
The first element of aiding and abetting - primary violations by Iron Holdings of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 - has been established. The remaining elements - substantial assistance and awareness - are present as well.
Knowing and substantial assistance to the conduct that constituted Iron Holdings's violations is clearly present. Respondents prepared an "Independent Auditors' Report" included with Iron Holdings's 1997 and 1998 Forms 10-KSB stating that they had audited the accompanying financial statements when they in fact were not independent.
Horton was a member of the AICPA SEC Practice Section, had conducted fifty auditing engagements for SEC reporting companies, and was aware of the Commission's requirements applicable to SEC reporting companies, which included a stress on independence that precluded any compilation services. In the alternative, if he was not aware of the Commission's independence requirement, he was reckless in not knowing that it forbade auditors from performing bookkeeping and compilation services when twenty-five to thirty-five percent of his practice involved audits for SEC reporting companies. The awareness or knowledge requirement can be satisfied by recklessness when the alleged aider and abettor is an active participant, as Horton was. Horton's awareness or reckless lack of knowledge is attributed to Horton & Company.
In sum, it is concluded that Iron Holdings violated Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 because the financial statements filed with its 1997 and 1998 Forms 10-KSB were not audited by an "independent public accountant," and Respondents willfully aided and abetted those violations.
Rule 102(e)(1)(ii) provides for sanctions against accountants who "have engaged in . . . improper professional conduct." "[W]ith respect to persons licensed to practice as accountants, `improper professional conduct' under Rule 102(e)(1)(ii) means intentional or knowing conduct, including reckless conduct, that results in a violation of applicable professional standards." 17 C.F.R. § 201.102(e)(1)(iv)(A).
The Division confirmed at the hearing that it was alleging that Respondents engaged in improper professional conduct under the recklessness standard. Tr. 5-10. Thus, consistent with the understanding of the parties, the undersigned judged the issue of Respondents' alleged improper professional conduct under the Commission's longstanding recklessness standard that was codified in 1998 as Rule 102(e)(1)(iv)(A). See Russell Ponce, 73 SEC Docket 442, 465 n.52 (Aug. 31, 2000), appeal pending, No. 00-71398 (9th Cir. 2000) (holding that 1998 amendment adding new subsection (iv)(A) to Rule 102(e)(1) merely codified the Commission's longstanding recklessness standard); accord, Albert Glenn Yesner, CPA, 70 SEC Docket 2743, 2748 (Oct. 19, 1999).
The Commission defines recklessness the same as recklessness under the antifraud provisions (for the purpose of consistency in the federal securities laws; "professional standards" are not fraud-based). Thus, recklessness is "an extreme departure from the standards of ordinary care, . . . which presents a danger of misleading buyers or sellers that is either known to the [actor] or is so obvious that the actor must have been aware of it." Amendment to Rule 102(e) of the Commission's Rules of Practice, 68 SEC Docket 707, 710; 63 Fed. Reg. 57164, 57167 (Oct. 26, 1998) (Rule 102(e) Amendment). It is "a lesser form of intent," "not merely a heightened form of ordinary negligence." Id. (internal citations and quotations omitted). That definition, with which the parties agree, will be applied here.
An auditor does not guarantee that financial statements are free of material misstatement. His "responsibility [is] to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud." AU § 110.02. Further, recklessness is more than a misapplication of accounting principles; the Division must prove that Respondents' "accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments . . . were such that no reasonable accountant would have made the same decision if confronted with the same facts;" reasonable accountants can differ, and evidence indicating that questioned accounting decisions were reasonable negates an attempt to establish scienter. See In re Worlds of Wonder Securities Litigation, 35 F.3d 1407, 1426 (9th Cir. 1994), quoting SEC v. Price Waterhouse, 797 F. Supp. 1217, 1240 (S.D.N.Y. 1992) (internal quotations omitted); accord In re Software Toolworks Inc., 50 F.3d 615, 627 (9th Cir. 1994) ("The mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter.") (citations and internal quotation marks omitted). Violations of GAAP or GAAS in themselves do not constitute recklessness. See Chill v. General Electric, 101 F.3d 263, 270 (2d Cir. 1996) ("Allegations of a violation of GAAP provisions or SEC regulations, without corresponding fraudulent intent, are not sufficient.").
Applicable professional standards include GAAP, GAAS, the AICPA Code of Professional Conduct and Commission Regulations. See Rule 102(e) Amendment, 68 SEC Docket at 709; 63 Fed. Reg. at 57166. The parties agree with this statement as indicated by their citation of such material in their pleadings.
The Division argues that the audits at issue did not comply with GAAS in that Respondents did not comply with various auditing standards pertaining to independence and to accounting for the Consulting Options.21 Thus, the Division argues, Respondents engaged in improper professional conduct. Respondents' arguments that their compilation and bookkeeping activities for Iron Holdings included few transactions and no exercise of judgment are relevant to the question of sanctions, but not to the question of violation in view of the Commission's strict policy on independence.
As concluded above, when Horton & Company provided an Independent Auditors' Report for Iron Holdings's 1997 and 1998 Forms 10-KSB, Respondents were not independent within the meaning of Regulation S-X. Horton knew, or in the alternative, was reckless in not knowing, that Respondents were not independent, for the reasons discussed above. Horton's state of mind was attributed to Horton & Company. It is concluded that Respondents' lack of independence was improper professional conduct within the meaning of Rule 102(e)(ii).
The Division also argues that Respondents violated various auditing standards in valuing the Consulting Options.22 For example, it argues that Respondents failed to obtain sufficient competent evidential matter in that they did not contact the recipients of the Consulting Options in order to value the services to be received. As Division expert Levine opined, however, attempting to value the services was impractical. Respondents cannot be faulted for not contacting the recipients, while there is no question that Respondents had sufficient competent evidential matter to value the Consulting Options using fundamental analysis. The Division cites additional instances in which they argue Respondents violated standards, such as that the audit was not adequately planned and Pirone was not adequately supervised. Again, whether or not the audit was adequately planned and supervised, as well as whether or not red flags indicated the possibility of fraud, and whether or not Horton exercised due professional care are outside the scope of the charges in the OIP except in relation to accounting for the Consulting Options. Since Horton's choice to evaluate accounting for the Consulting Options was reasonable and permissible under GAAP, Respondents did not engage in improper professional conduct concerning the Consulting Options.
In sum, it is concluded that Respondents engaged in improper professional conduct within the meaning of Rule 102(e)(1)(ii) because they were not independent within the meaning of Regulation S-X in their audits of Iron Holdings's financial statements filed with its 1997 and 1998 Forms 10-KSB.
The Division requests that Respondents be censured and be denied the privilege of appearing or practicing before the Commission for two years. Respondents request that the proceeding be dismissed. For the reasons discussed below, Respondents will be denied the privilege of appearing or practicing before the Commission for one year.
When the Commission determines administrative sanctions, it considers:
[T]he egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d at 1140.23
Respondents diminish the significance of their bookkeeping and compilation services for Iron Holdings. Iron Holdings's transactions were relatively few in number compared to the hundreds of transactions per month of Iron Eagle, which accounted for 95% of the 1997 audit engagement and a large proportion of the 1998 engagement as well. These facts mitigate the egregiousness of the independence violation to some extent. Independence, however, is a crucial concept in auditing and in requirements for financial statements filed by public corporations with the Commission. It could not be clearer that the Commission does not accept as independent an auditor who has performed bookkeeping and compilation services.
The infraction was not isolated since Respondents audited and furnished an "Independent Auditors' Report" for the financial statements filed with the 1997 and 1998 Forms 10-KSB and also continued their compilation services for more than one year. Concerning scienter, Respondents were not charged with fraud. They were, however, reckless in their neglect of independence. Consistent with defending the charges against them, Respondents sought to minimize any wrongfulness of their conduct. Horton's occupation will present opportunities for future violations. Horton & Company, while inactive, is still extant, and thus a sanction should be imposed against it as well.
A one-year suspension is an appropriate sanction and consistent with Commission precedent.24 Because of Horton's role in Horton & Company, the same sanction against each Respondent is appropriate. Because of the suspension, the lesser sanction of censure is unnecessary.25 Accordingly, the undersigned will order that Horton and Horton & Company each be denied, temporarily, the privilege of appearing or practicing before the Commission as an accountant.26
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), it is certified that the record includes the items set forth in the record index issued by the Secretary of the Commission on March 8, 2002.
Pursuant to 17 C.F.R. § 201.102(e)(1), and based on the findings and conclusions set forth above:
IT IS ORDERED that Edward C. Horton IS DENIED TEMPORARILY the PRIVILEGE OF APPEARING OR PRACTICING BEFORE THE COMMISSION AS AN ACCOUNTANT for a period of ONE YEAR.
IT IS FURTHER ORDERED that Horton & Company IS DENIED TEMPORARILY the PRIVILEGE OF APPEARING OR PRACTICING BEFORE THE COMMISSION AS AN ACCOUNTANT for a period of ONE YEAR.
This Order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R. § 201.360. Pursuant to that rule, a petition for review of this Initial Decision may be filed within twenty-one days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within twenty-one days after service of the Initial Decision upon such party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this Initial Decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the Initial Decision shall not become final as to that party.
Carol Fox Foelak
Administrative Law Judge
1 Citations to the transcript of the hearing will be noted as "Tr. ___." Citations to exhibits offered by the Division and Respondents will be noted as "Div. Ex. ___," and "Resp. Ex. ___," respectively.
2 See 5 U.S.C. § 557(c).
3 The company will be referred to as "Iron Holdings" in this Initial Decision. In the record of evidence it is primarily referred to as "Iron Holdings" rather than "Monarch."
4 GAAP are the basic postulates and broad principles of accounting pertaining to business enterprises. These principles establish guidelines for measuring, recording, and classifying the transactions of a business entity. See SEC v. Arthur Young & Co., 590 F.2d 785, 789 n. 4 (9th Cir. 1979).
5 GAAS are the standards prescribed by the Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) for the conduct of auditors in the performance of an examination of management's financial statements. See Id. at 788 n.2. Citations to GAAS will be made to the Codification of Statements on Auditing Standards, issued by the Auditing Standards Board of the AICPA, as "AU § ___."
6 JJFN, now known as Strategic Capital Resources, is a publicly traded company in the business of purchasing model homes from real estate developers and leasing them back to the developers. Tr. 442. After the sale JJFN engaged Kenneth MacKenzie, a JJFN director and business appraiser, to appraise the value of Iron Eagle as of the date it was sold. The reason for the appraisal was the potential for officer and director liability if the subsidiary were sold for less than its fair market value. MacKenzie valued it at $700,000. Tr. 444, 572-80; Resp. Ex. 13. MacKenzie's connection with JJFN indicates a conflict of interest; thus his $700,000 valuation is not accepted.
7 The public shell was Comstock Tailings Company, Incorporated, a Nevada corporation. Div. Ex. 87 at 6, Div. Ex. 88 at 5. It acquired Iron Holdings Corporation, a New York corporation and holding company for Iron Eagle, on March 31, 1997, for 4.5 million shares of restricted common stock. Div. Ex. 87 at 17-18, Div. Ex. 88 at 5. The surviving corporation was known as Iron Holdings until it changed its name to Monarch, on June 29, 1998. Div. Ex. 87 at 6, Div. Ex. 88 at 5.
8 After the split there were 668,733 shares issued and outstanding. The post-split values were used in the 1998 Form 10-KSB. Div. Ex. 88 at 44.
9 The options are more accurately described as "warrants." Exercising "warrants" causes a company to issue new stock, while "options" involve the exchange of already issued stock between the parties. Div. Ex. 103 at 3-4. The term "options" is used here, consistent with the evidence adduced in the hearing.
10 These proceeds allowed Iron Holdings to prepay $212,500 of its obligation due under the terms of its long-term debt agreement with JJFN and pay all of the interest that it had accrued thereunder. Div. Ex. 87 at 47.
11 The four consulting firms that received the Consulting Options were Meersbrook Ltd, a West Indies corporation; Stockplayer.com, Inc., a Delaware corporation; Windlass Capital Management Ltd., a West Indies corporation; and Inter Capital Holding Corp., a New York corporation. Div. Exs. 57, 57A, 58, 58A, 59, 59A, 60, 60A.
12 Iron Holdings's consolidated balance sheet as of June 30, 1997, also listed a stockholders' deficit of $5,000 for the 5,000,000 shares that it had issued and outstanding in 1997 at a par value of $0.001 per share. Div. Ex. 87 at 27.
13 Auditing standards recognize that "the auditor is able to obtain reasonable, but not absolute, assurance that material misstatements are detected. Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated." (footnotes omitted) AU § 312.02. The three components of audit risk are inherent risk ("the susceptibility of an assertion to a material misstatement, assuming that there are no related controls"), control risk ("the risk that a material misstatement . . . will not be prevented or detected on a timely basis by the . . . internal control" of the entity being audited), and detection risk ("the risk that the auditor will not detect a material misstatement," for example, when the auditor does not examine all transactions). AU § 312.27.
14 A going concern opinion indicates doubt that the company will survive as a going concern for another year. Tr. 61, 500-01.
15 To the extent that the evidence of the expert witnesses does not lead to findings of fact, it will be summarized here and referred to as appropriate in the Conclusions of Law section of this Initial Decision.
16 Division expert Sack described the Anchor options as a "bet." Tr. 235, 322; Div. Ex. 104 at 5. Viewing them as a "bet" reduces the validity of using them in a Black-Scholes analysis. Sack, however, was not accepted as an expert in valuing options.
17 Levine also opined, in a conclusory manner, that, based on net income, $4,000 was the appropriate materiality threshold for 1997. Tr. 643-53; Div. Ex. 103 at 7. Horton selected $37,000, based on revenue, as the materiality threshold for 1997; he explained his opinion, based on AICPA guidance, that revenue was more appropriate than net income for the Iron Holdings engagement. Tr. 484-86. Levine did not address Horton's reasoning or explain why he chose net income. Levine also opined, in a conclusory manner, that the $348,880 should have been accounted for as an expense in the 1997 income statement. Tr. 643-53; Div. Ex. 103 at 7. Sack, however, not Levine, was accepted as an expert on accounting for the Consulting Options, and Levine's opinion was not entirely consistent with Sack's.
18 Part 210 of 17 C.F.R. (17 C.F.R. §§ 210.1-.12) is also known as Regulation S-X.
19 At the time at issue 17 C.F.R. §§ 210.2-01(b) (amended 2000) provided, "The Commission will not recognize any certified public accountant or public accountant as independent who is not in fact independent."
20 After the events in question the Commission amended Regulation S-X to codify the prohibition. See 17 C.F.R. § 210.2-01(c)(4)(i), and Revision of the Commission's Auditor Independence Requirements, 73 SEC Docket 2601, 2636-37; 65 Fed. Reg. 76008, 76043-44 (Dec. 5, 2000). The amended rule, effective February 5, 2001, merely codified the Commission's longstanding prohibition. The Commission's bright-line independence standard, which is not based on materiality concerns, is stricter than GAAS. Compare the Commission's standard with GAAS - AU §§ 150.02 (listing the ten basic GAAS standards, including "independence in mental attitude") and 150.03 ("'Materiality' . . . underlie[s] the application of all the standards"). The different standard for independence of auditors who report on financial statements filed with the Commission is recognized in AU § 220.05.
21 The OIP does not specify any particular professional standard that Respondents allegedly violated. Rather, it charges that Respondents engaged in improper professional practice, based on alleged facts related to independence and the options. The OIP does not charge any other auditing or accounting impropriety. Thus, for purposes of the Conclusions of Law the undersigned has disregarded any reference in post-hearing filings to practices or standards that do not relate to the independence and Consulting Options issues.
22 The ten basic GAAS standards are listed in AU § 150.02, and detailed interpretations follow. Those that the Division argues are particularly applicable in this proceeding are the third general standard (Due professional care) and AU § 230 (Due Professional Care); the first standard of field work (Planning and Supervision) and AU §§ 311 (Planning and Supervision), 312 (Audit Risk and Materiality), and 316 (Fraud); the third standard of field work (Sufficient competent evidential matter) and AU §§ 326 (Evidential Matter), 330 (The Confirmation Process), and 333 (Reliance on Management Representations); the first standard of reporting ("The report shall state whether the financial statements are presented in accordance with [GAAP]"); and the fourth standard of reporting (Expression of opinion regarding the financial statements) and AU § 508 (Reports on Audited Financial Statements).
23 The Division cites the Steadman factors in requesting a two-year suspension. See also Carroll A. Wallace, CPA, 73 SEC Docket 3969, 4034-37 (A.L.J. Dec. 18, 2000), Barry C. Scutillo, CPA, 74 SEC Docket 2497, 2555-57 (A.L.J. May 3, 2001) (applying Steadman factors in Rule 102(e) proceedings against CPAs).
24 See Russell Ponce, 73 SEC Docket 442 (Aug. 31, 2000) (ordering a bar with right to reapply in five years and cease and desist order; CPA violated antifraud provisions, lacked independence due to unpaid fees, changed properly expensed costs to capitalize them based solely on management representations, and inflated value of intangible asset); Robert D. Potts, CPA, 53 S.E.C. 187 (1997), aff'd, 151 F.3d 810 (8th Cir. 1998), cert. denied, 526 U.S. 1097 (1999) (suspending concurring partner for nine months; accounting for asset not in accord with GAAP and contrary to documentary evidence in file he reviewed); Bill R. Thomas, 48 S.E.C. 1007 (1988) (barring, permanently, CPA who violated antifraud provisions, owned stock in firm he audited, and concealed this from his employer, a national accounting firm); Gary L. Jackson, 48 S.E.C. 435 (1986) (barring, permanently, CPA who aided and abetted firm's filing of materially false reports and knowingly accepted firm's valuation of worthless mining claims and of an asset based on a sham transaction with no economic substance); Russell G. Davy, 48 S.E.C. 138 (1985) (barring, permanently, CPA who violated antifraud provisions, accepted management representations about sham transactions despite red flags and ignored information that he actually knew); Ernst & Ernst, 46 S.E.C. 1234 (1978) (suspending engagement partner for one year, audit manager, for three months, and censuring CPA firm; materially false and misleading financial statements contained sham and improperly accounted for acquisitions, and respondents lacked independence in repeated dependence on management representations concerning significant information despite red flags).
25 This is consistent with Commission precedent cited above. In sanctioning a CPA, the Commission has chosen either censure or a denial of the privilege to practice or appear before it, but not both.
26 The Division indicates that, to resume practice before the Commission after the suspension period, Respondents should apply for reinstatement and meet various conditions. However, the suspension period is temporary, not permanent, and the reinstatement application provisions of Rule 102(e)(5) do not apply. Further, an accountant is not a registrant, or a person associated with a registrant, with the Commission, unlike, e.g., a broker-dealer, and the Commission's rules do not otherwise provide for such an application process or for conditions. Compare the sanctions provided in Rule 102(e)(1) ("The Commission may censure . . . or deny, temporarily or permanently, the privilege of appearing or practicing before it in any way . . .") with Exchange Act Section 15(b)(4) ("The Commission . . . shall censure, place limitations on the activities, functions, or operations of, suspend for a period not exceeding twelve months, or revoke the registration of any broker or dealer . . .").
Settlements of Rule 102(e) proceedings do include conditions and do include an application process if the term of temporary denial is one year or more. See, e.g., Kenneth W. Haver, CPA, 77 SEC Docket 1427, 1429-30 (Apr. 24, 2002); Lawrence R. Reich, CPA, 60 SEC Docket 756, 763-64 (Sept. 18, 1995). In settling, however, the CPA respondents have agreed to those extra terms, and, it goes without saying, settlements are not precedent, as the Commission has stressed many times. See Richard J. Puccio, 52 S.E.C. 1041, 1045 (1996) (citing David A. Gingras, 50 S.E.C. 1286, 1294 (1992), and cases cited therein); Robert F. Lynch, 46 S.E.C. 5, 10 n.17 (1975) (citing Samuel H. Sloan, 45 S.E.C. 734, 739 n.24 (1975); Haight & Co. Inc., 44 S.E.C. 481, 512-13 (1971); Security Planners Assocs., Inc., 44 S.E.C. 738, 743-44 (1971)); see also Kelley ex rel. Michigan Dep't of Natural Res. v. FERC, 96 F.3d 1482, 1489-90 (D.C. Cir. 1996), and cases cited therein. Commission settlement orders contain disclaimers to this effect. See, e.g., Bear, Stearns Sec. Corp., 70 SEC Docket 710, 711 n.1 (Aug. 5, 1999).
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