SEC Finds PricewaterhouseCoopers LLP Engaged in Improper Professional Conduct

FOR IMMEDIATE RELEASE
2003-65

PwC is Censured and Agrees to Pay $1 Million, Establish New Document Retention Policies and Retain an Independent Consultant

Washington, D.C., May 22, 2003 — - The Securities and Exchange Commission today announced a settled enforcement action against PricewaterhouseCoopers LLP (PwC) for improper professional conduct in connection with its audit of SmarTalk TeleServices, Inc.'s (SmarTalk) year-end 1997 financial statements. As described in the SEC's order, SmarTalk, a now-bankrupt provider of pre-paid telephone cards and wireless services, filed with the Commission an annual report on Form 10-K, which contained materially false and misleading financial statements. Those financial statements were audited by PwC.

The SEC found that PwC, through Philip Hirsch, formerly with PwC and the engagement partner on the audit, failed to comply with Generally Accepted Auditing Standards (GAAS) in the conduct of its audit. In addition, the SEC found that in late July 1998, after the audit was completed and after Hirsch left the firm, PwC identified potential issues with SmarTalk's 1997 financial statements and its audit and became aware of a class action -shareholder lawsuit alleging accounting fraud against SmarTalk. The SEC found that from the end of July through early August 1998, with the knowledge of several PwC partners with firm-wide responsibility, PwC made revisions to its working papers. The SEC also found that PwC voluntarily produced documents to the staff in February 1999 that included listings of computer files showing that certain working paper files had been accessed in early August 1998, but PwC did not tell the staff until November 1999, that some working papers and other documents relating to PwC's audit report had been revised, created and discarded.

In today's order, the SEC censured PwC for engaging in "improper professional conduct" within the meaning of Rule 102(e) of the SEC's Rules of Practice by virtue of its failure to adequately audit a $25 million restructuring reserve established by SmarTalk at fiscal year-end 1997 and to adequately audit amounts charged against the restructuring reserve at year-end 1997. PwC, without admitting or denying the SEC's findings, agreed to pay $1 million. It also agreed to significant remedial undertakings, including establishing and maintaining policies and procedures to preserve working papers intact and retaining an independent consultant to, among other things, review PwC's software system to confirm that it is designed to meet the objectives of those policies and procedures.

"This case is an example of the Division of Enforcement's intention to adopt a new enforcement model - one that holds an accounting firm responsible for the actions of its partners," said Antonia Chion, an Associate Director of Enforcement. "It also highlights the firm's failure to maintain the integrity of its audit working papers."

The SEC's order finds that:

• PwC and Hirsch failed to adequately audit SmarTalk's establishment of a $25 million restructuring reserve at fiscal year-end 1997, purportedly for anticipated 1998 costs associated with its earlier purchase of six other prepaid telephone card businesses. The Commission found that PwC and Hirsch should have known that the entire restructuring reserve was improper as it did not conform to Generally Accepted Accounting Principles (GAAP) because the anticipated costs were not proper restructuring costs and the company had failed to properly establish a plan of restructuring in conformity with Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). Additionally, the Commission found that SmarTalk improperly understated current period operating expenses by charging 1997 operating expenses against the non-GAAP restructuring reserve and that PwC and Hirsch failed to adequately audit amounts charged against the restructuring reserve at year-end 1997.
   
• Several months after the audit was completed, when PwC was considering resigning as SmarTalk's auditors, it conducted a post-audit review of the 1997 audit working papers. In July 1998, the PwC post-audit reviewer identified potential issues with SmarTalk's year-end 1997 financial statements, as well as the audit. In late-July 1998, PwC became aware of a class action shareholder lawsuit alleging accounting fraud against SmarTalk and certain of its officers and directors. PwC was not named as a defendant in that lawsuit until September 21, 1998.
   
• From the end of July through early August 1998, with the knowledge of several PwC partners with firm-wide responsibilities, PwC made revisions to its working papers. Those revisions were not documented. Language in the working papers was revised, added and deleted. Documents were removed from the working papers and discarded and documents were also added to the working papers. In addition, during this period, PwC deleted and discarded most of its "desk files." At the time of PwC's conduct, there was no SEC investigation of SmarTalk's accounting or financial disclosures.
   
• In August 1998, PwC informed SmarTalk of the need to restate SmarTalk's financial statements. In November 1998, SmarTalk restated its financial statements for year-end 1997, as well as for the first two quarters of 1998, reversing the entire $25 million restructuring reserve that had been recorded at year-end 1997. SmarTalk also expensed most of the operating costs that had previously been charged against the restructuring reserve.

The SEC found that PwC, through Hirsch in connection with the audit of SmarTalk's 1997 financial statements, engaged in repeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards. The SEC also found that the failures of Hirsch to comply with GAAS in the conduct of the audit bind and are imputed to PwC. Furthermore, the SEC found that it is appropriate to sanction and seek other relief from PwC for the audit failures because PwC made undocumented changes to its 1997 audit working papers and discarded other documents relevant to its audit.

The SEC today also instituted a settled administrative proceeding against Hirsch for improper professional conduct under Rule 102(e). Hirsch, without admitting or denying the SEC's findings, consented to an order denying him the privilege of appearing or practicing before the Commission as an accountant, with the right to apply to resume appearing or practicing before the Commission after one year. Previously, the SEC instituted settled enforcement actions against SmarTalk's CFO Glen Andrew Folck for violating or causing violations of certain antifraud, reporting, and books and records provisions of the federal securities laws. Folck, without admitting or denying the SEC's findings and allegations, consented to a cease and desist order, paid $22,844 in disgorgement and prejudgment interest and also paid a $50,000 civil penalty. See Litigation Release No. 18002 (February 27, 2003).