UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 36921 / March 5, 1996 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 767 / March 5, 1996 ADMINISTRATIVE PROCEEDING File No. 3-8967 ___________________________________ : In the Matter of : ORDER INSTITUTING : PROCEEDINGS AND OPINION JOHN M. GOLDBERGER, CPA, and : AND ORDER PURSUANT TO : RULE 102(e) OF THE C. KIRK FRENCH, CPA, : COMMISSION'S RULES OF : PRACTICE Respondents. : ___________________________________: I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be and they hereby are instituted against John M. Goldberger, CPA, and C. Kirk French, CPA, pursuant to Rule 102(e)(1) of the Commission's Rules of Practice.-[1]- II. In anticipation of the institution of these administrative proceedings, Goldberger and French have submitted Offers of Settlement which the Commission has determined to accept. Solely for the purposes of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice, and without admitting or denying the facts, findings, or conclusions herein, Goldberger and French consent to entry of the findings, and the imposition of the remedial sanctions set forth below. ---------FOOTNOTES---------- -[1]- The Rule provides in relevant part that "the Commission may . . . deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found by the Commission after notice and opportunity for hearing in the matter . . . to have engaged in . . . improper professional conduct." Rule 102(e)(1)(ii). ==========================================START OF PAGE 2====== III. FINDINGS On the basis of this Order and the Respondents' Offers of Settlement, the Commission finds the following:-[2]- A. Individuals and Entities 1. Respondents John M. Goldberger, age 45, is a certified public accountant licensed by the Commonwealth of Pennsylvania and was an audit partner in the Pittsburgh office of the accounting firm of Grant Thornton from 1982 until July 31, 1995. He was the concurring review partner on the 1983 through 1987 audits of Chambers Development Company, Inc. Goldberger was the audit partner on the 1990 and 1991 Chambers audits. C. Kirk French, age 49, is a certified public accountant licensed by the Commonwealth of Pennsylvania and was a senior manager in the audit department of the Pittsburgh office of Grant Thornton from June 1987 until April 1995. He served as audit manager and engagement administrator for the 1987 through 1989 Chambers audits and as senior manager for the 1990 and 1991 audits. 2. Other Entities Grant Thornton is a national public accounting firm with its headquarters in Chicago. Grant Thornton was Chambers' independent auditor from 1983 until April 1992. Chambers Development Company, Inc., is a Delaware corporation with its principal place of business in Pittsburgh. It is in the business of collecting, hauling and disposing of solid waste, of building and operating solid waste sanitary landfills and related operations. Chambers stock was publicly traded from 1985 until June 30, 1995. During the period relevant here, Chambers stock was traded on the American Stock Exchange and registered with the Commission pursuant to Section 12(b) of the Exchange Act.-[3]- ---------FOOTNOTES---------- -[2]- The findings herein are made pursuant to the Offers of Settlement submitted by Goldberger and French and are not binding on any other person or entity named as a respondent in this or any other proceeding. -[3]- Chambers stock ceased to be publicly traded when Chambers became a wholly-owned subsidiary of USA Waste Services, Inc., on June 30, 1995. ==========================================START OF PAGE 3====== B. INTRODUCTION This opinion and order relates to Grant Thornton's audits of Chambers' financial statements for the years ended December 31, 1989, and 1990. In both years, Grant Thornton issued audit reports containing unqualified opinions and statements that the company's financial statements were fairly presented in conformity with generally accepted accounting principles ("GAAP") and that the audits were conducted in accordance with generally accepted auditing standards ("GAAS"). In fact, as explained below, the company's financial statements were not presented in conformity with GAAP, and the auditors failed to conduct the 1989 and 1990 audits in accordance with GAAS. Restated financial statements filed with the Commission on December 30, 1992, reduced Chambers' net earnings reported for 1989 and 1990 from a total of $61.5 million to a total net loss of $57.1 million. During 1989 and 1990, Chambers understated its expenses and overstated its earnings by engaging in certain fraudulent capitalization practices. Chambers calculated expenses and capitalized costs based on profit margins management determined in advance. In preparing its financial statements during this period, Chambers calculated its expenses based on percentages of revenue and capitalized or deferred the remainder of its costs. Company personnel did not prepare documentation showing allocations of these amounts out of expense accounts and into asset accounts until after Chambers publicly announced its earnings for the period.-[4]- ---------FOOTNOTES---------- -[4]- The Commission filed a separate, civil injunctive action against Chambers. See SEC v. Chambers Development Co., Inc., Lit. Rel. No. 14496 (W.D. Pa., filed and settled May 9, 1995) (alleging violations of Sections 10(b), 13(a) and 13(b) of the Exchange Act and Rules 10b-5, 13a-1, 13a-13, and 12b-20 thereunder, and Section 17(a) of the Securities Act of 1933). The Commission also issued orders commencing administrative proceedings against five Chambers officers relating to the company's capitalization practices during 1989 through March 17, 1992, and accepting their offers of settlement. In re John G. Rangos, Sr., Admin. Proc. File No. 3-8692, Exchange Act Rel. No. 34-35693, Accounting and Auditing Enforcement Rel. No. 672 (May 9, 1995); In re John J. Cushma, Admin. Proc. File No. 3-8690, Exchange Act Rel. No. 34-35691, Accounting and Auditing Enforcement Rel. No. 670 (May 9, 1995); In re William R. Nelson, Admin. Proc. File No. 3-8689, Exchange Act Rel. No. 34-35690, Accounting and Auditing Enforcement Rel. No. 669 (May 9, 1995); In re Dale O. Nolder, Jr., Admin. Proc. File No. 3-8691, Exchange Act Rel. No. 34-35692, Accounting and Auditing Enforcement Rel. (continued...) ==========================================START OF PAGE 4====== Chambers originally reported 1990 pre-tax income of $34.4 million. After restating its 1990 financial statements to correct for the improper capitalization of costs, Chambers reported a 1990 pre-tax loss of $40.6 million. During 1990, Chambers capitalized $97 million of landfill site acquisition and development costs. Similarly, Chambers originally reported 1989 pre-tax income of $27.1 million. After restating its 1989 financial statements to correct for the improper capitalization of costs, Chambers reported a 1989 pre-tax loss of $16.5 million. During 1989, Chambers capitalized $58 million of landfill site acquisition and development costs. Goldberger was the audit partner and French was the senior manager for the 1990 audit. French also was the audit manager on the 1989 Chambers audit. French conducted audit procedures and prepared the principal workpapers related to capitalized costs for the 1989 and the 1990 audits. Goldberger reviewed and approved the audit programs and workpapers, including those related to capitalized costs for the 1990 audit.-[5]- As described below, Goldberger and French engaged in improper professional conduct within the meaning of Rule 102(e) in that they failed to conduct the 1990 Chambers audit in accordance with GAAS. Goldberger and French (1) failed to obtain sufficient competent evidential matter to afford a reasonable basis for Grant Thornton's opinion on Chambers' financial statements; (2) failed to assess properly whether the company's financial statements were fairly presented in accordance with GAAP; and (3) failed to exercise due professional care in the performance of the audit. French also engaged in improper professional conduct within the meaning of Rule 102(e) in that he failed to conduct the 1989 Chambers audit in accordance with GAAS. C. Failures to Obtain Sufficient, Competent Evidential Matter ---------FOOTNOTES---------- -[4]-(...continued) No. 671 (May 9, 1995); In re Richard A. Knight, Admin. Proc. File No. 3-8694, Exchange Act Re. No. 34-36893, Accounting and Auditing Enforcement Rel. No. 764 (February 27, 1996). -[5]- In years prior to 1990, Goldberger's predecessor as the audit partner on the Chambers audits reviewed and approved the audit programs and workpapers. After the 1989 audit, Goldberger's predecessor became the chief financial officer of Chambers. ==========================================START OF PAGE 5====== In 1990, Goldberger and French primarily relied on analytical procedures to test the $97 million Chambers had capitalized as landfill site and acquisition and development costs. French had prepared an audit program setting forth these procedures for the 1987 audit and Grant Thornton had applied them since then without material changes. In 1990, as in the past, these procedures included comparisons by expense category of amounts capitalized to amounts incurred for the year ended December 31, 1990, and for the preceding five-year period. The audit procedures also included inquiries of Chambers' controller and other personnel to relate development activities to amounts capitalized. French interviewed individuals about the factors considered when the amounts capitalized were derived, and he believed Chambers based the amounts capitalized on inquiry and observation of landfill development activities. But French neither documented such findings in the workpapers, nor examined documentation to support the estimates. He did not know whether Chambers prepared documentation for the assumptions used to determine the estimates. The auditors' workpapers reflect certain inquiries and other procedures concerning increases in the amounts of capitalized labor, professional services and miscellaneous expenses over those capitalized in the previous year. For example, capitalized labor increased from $22.6 million in 1989 to $40 million in 1990. Goldberger and French did not corroborate with other evidential matter management's responses to inquiries concerning this material increase in labor costs. French knew in the course of the 1990 audit that Chambers had not maintained labor records for development costs. However, the audit workpapers do not reflect any consideration of the possibility that a lack of supporting documentation may have been an indication that the company's financial statements were materially misstated.-[6]- The capitalized amount of professional services costs also was not corroborated by sufficient evidential matter. In 1990, Chambers capitalized as landfill sites $7.2 million of expenditures for legal, engineering and accounting services. The workpapers refer to a schedule prepared by Chambers of legal costs incurred in 1990, but neither the schedule nor the workpaper indicates which legal expenses were actually ---------FOOTNOTES---------- -[6]- The 1989 workpapers reflect a similar approach. In those workpapers, French noted management's response to his inquiries about increases in the percentages of labor capitalized in 1989 over 1988, but he did not corroborate this response with a review of other evidential matter, such as contemporaneously prepared time records. ==========================================START OF PAGE 6====== capitalized or whether any supporting documentation was reviewed to determine the propriety of the amounts capitalized. Chambers incurred and capitalized miscellaneous costs of $8.2 million and $4.6 million, respectively, in 1990, and $1.3 million and $.4 million, respectively, in 1989. The workpapers reflect management's responses to inquiries about the nature of the costs incurred but not capitalized, and add that "[t]he remaining costs were capitalized as they relate [to] the phased development of the landfill." Nothing in the workpapers explains the increase over 1989 in capitalized miscellaneous costs or addresses the nature or propriety of capitalized miscellaneous costs.-[7]- GAAS as promulgated by the American Institute of Certified Public Accountants include the general standards, the standards of fieldwork and the standards of reporting. The third standard of fieldwork states: Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. SAS No. 1 (Generally Accepted Auditing Standards) (AU 150.02).-[8]- Goldberger and French did not comply with this standard. First, their audit procedures failed to test the propriety and accuracy of the underlying accounting data supporting the company's capitalization figures as required by SAS No. 31 (Evidential Matter) (AU 326).-[9]- Such tests would have revealed a lack of sufficient documentation supporting the capitalization entries and might have revealed the ---------FOOTNOTES---------- -[7]- Similarly, the 1989 workpapers reflect that Chambers capitalized $1.2 million in rent/maintenance during the year ended December 31, 1989, yet they do not document any attempt by French to corroborate management's representations with other evidential matter, such as the supporting documentation related to leased equipment used in the development of landfill sites. -[8]- GAAS citations are to the American Institute of Certified Public Accountants' Statements on Auditing Standards ("SAS"), followed by the section and paragraph number of AICPA, Codification of Statements on Auditing Standards (1989). -[9]- Underlying accounting data includes "the books of original entry, the general and subsidiary ledgers, related accounting manuals, and such informal records as worksheets supporting cost allocations, computations, and reconciliations." (AU 326.15). ==========================================START OF PAGE 7====== irregularities in the company's capitalization methods.-[10]- Second, although Goldberger and French understood that Chambers estimated its capitalization figures, they failed to comply with SAS No. 57 (Auditing Accounting Estimates) (AU 342) in auditing these estimates. They neither "obtain(ed) an understanding of how management developed the estimate" (AU 342.10), nor did they evaluate whether Chambers had accumulated "relevant, sufficient and reliable data on which to base the estimate" (AU 342.05c & .07). Third, the analytical procedures on which Goldberger and French primarily relied were not sufficient, competent evidential matter. SAS No. 56 (Analytical Procedures) (AU 329). Their reliance on historical percentages during a period when the company's business was changing rapidly-[11]- and on management's representations was inappropriate given the level of assurance they required from these analytical procedures. SAS No. 56 states: inquiry of management may assist the auditor in this regard. Management responses, however, should ordinarily be corroborated with other evidential matter. (AU 329.21). In sum, Goldberger and French failed to corroborate management's responses to their inquiries with other evidential matter, and to the extent these responses were documented in the ---------FOOTNOTES---------- -[10]- During the 1991 audit, the auditors insisted on reviewing the underlying accounting data supporting Chambers' 1991 capitalization figures. Their demands for this data ultimately led to the exposure of the company's fraudulent accounting practices. Chambers first revised the earnings initially announced for the fourth quarter and year ended December 31, 1991, then terminated Grant Thornton as its auditor and ultimately restated its financial statements for 1989, 1990 and the first three quarters of 1991. -[11]- From the time of the company's initial public offering in October 1985 through 1990, its operations expanded from three landfill sites to 15 landfill sites, various related operations and a security services business. Its revenues grew from $20 million for the year ended December 31, 1985, to $258 million for the year ended December 31, 1990. ==========================================START OF PAGE 8====== workpapers, they generally were neither relevant nor persuasive.-[12]- D. Failure Related to Capitalized Interest Goldberger and French failed to assess properly whether Chambers' financial statements were presented in accordance with GAAP as it related to the capitalization of interest charges incurred to construct landfill sites. The company's restated financial statements reflect expenses of $8.3 million for interest improperly capitalized in its original 1990 financial statements and $9.2 million for interest improperly capitalized in its original 1989 financial statements. The restatement of capitalized interest resulted from material decreases in assets qualifying for interest capitalization. The decreases in qualifying assets resulted from the reversal of: 1) unsupported capitalized costs recorded in prior years; and 2) non-qualifying costs of infrastructure related to already operating landfills. Statement of Financial Accounting Standards No. 34 establishes GAAP for interest capitalization.-[13]- It provides that assets qualifying for interest capitalization include "assets that are constructed . . . for an enterprise's own use . . . ." SFAS No. 34, 9. Chambers originally included as qualifying assets $55 million and $33 million of unsupported capitalized costs for the years ended December 31, 1990, and 1989, respectively. As a result of the audit failures outlined in Part III.C above, Goldberger and French failed to determine that these costs were not in fact assets qualifying for interest capitalization. In addition, included in Chambers' qualifying assets were $67 million in infrastructure costs related to landfills placed in service in whole or in part by the end of 1989. The auditors' workpapers indicate the amount was an estimate of infrastructure costs allocable to parts of landfills still under development. The estimate represented 60 percent of infrastructure costs incurred through December 31, 1989. ---------FOOTNOTES---------- -[12]- SAS No. 31 (Evidential Matter) (AU 326.18 & .19); SAS No. 19 (Client Representations) (AU 333.02); See In re Ernst & Whinney, [1990 Transfer Binder] Fed. Sec. L. Rep. (CCH) 84,610 at 80,918, 80,927-29 (June 28, 1990). -[13]- Financial Accounting Standards Board (FASB), Statement of Financial Accounting Standards No. 34, Capitalization of Interest Costs (1979), reprinted in FASB, 1 Original Pronouncements: Accounting Standards as of June 1, 1994 343. ==========================================START OF PAGE 9====== Under SFAS No. 34, 18, "[t]he capitalization period shall end when the asset is substantially complete and ready for its intended use." The relevant infrastructure assets did not qualify for interest capitalization because they were in use or substantially complete and ready for their intended use during 1989, when Chambers began accepting waste at the landfills. Chambers capitalized interest costs on a portion of the costs incurred in constructing its infrastructure assets, based on an estimate of the percentage of land remaining to be developed at each site, on the theory that such assets were in use at less than full capacity. This theory is inconsistent with SFAS No. 34, which permits the division of assets into components for the purpose of interest capitalization only when the assets are "completed in parts, and each part is capable of being used independently while work is continuing on other parts." Goldberger and French failed to recognize that the infrastructure at Chambers' landfills did not meet the conditions for a division, or allocation, of costs in determining the interest capitalization period. E. Failure to Exercise Due Care The audit failures described above show the auditors did not exercise due professional care in the performance of the audits. SAS No. 1 (AU 150.02). The auditors' failure to exercise due care also is apparent from their failure to maintain an attitude of professional skepticism when they were confronted with circumstances indicating possible irregularities in Chambers' accounting records. The workpapers for the 1990 audit contain notes by French indicating that the company released earnings before Chambers finished preparing detailed capitalization entries. In addition, Goldberger and French knew the company's final, year-end capitalization schedules for the 1990 audit were not readily available or promptly produced when requested by Grant Thornton. In fact, the auditors did not receive final capitalization schedules until February 19, 1991, one day before the audit report was signed. These facts should have caused Goldberger and French to consider whether Chambers' financial statements contained material misstatements. SAS No. 53 (The Auditor's Responsibility to Detect and Report Errors and Irregularities) (AU 316.21). IV. ORDER IMPOSING REMEDIAL SANCTIONS Accordingly, IT IS HEREBY ORDERED that: A. Goldberger and French are denied the privilege of appearing or practicing before the Commission as accountants. ==========================================START OF PAGE 10====== B. Eighteen months after the date of the Order, Goldberger and French may apply to resume appearing or practicing before the Commission as: 1. preparers or reviewers of financial statements required to be filed with the Commission or persons responsible for the preparation or review of financial statements required to be filed with the Commission provided that, in their practice before the Commission, their work will be overseen by the independent audit committee of the company or in some other manner acceptable to the staff of the Commission; 2. independent public accountants upon submission of an application to the Office of the Chief Accountant of the Commission containing a showing satisfactory to the Commission that: (a) Goldberger or French, or any firm with which they are or become 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"); (b) Goldberger or French, or any firm with which they are or become associated in any capacity, 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 (c) Goldberger or French, or any firm with which they are or become 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; 3. The Commission's review of Goldberger's or French's application to resume appearing or practicing before it may include consideration of any other matter relating to Goldberger's or French's character, integrity, professional conduct or qualifications to practice before the Commission. By the Commission. Jonathan G. Katz Secretary