UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Release No. 40098 / June 17, 1998 ACCOUNTING AND AUDITING ENFORCEMENT Release No. 10044 / June 17, 1998 ADMINISTRATIVE PROCEEDING File No. 3-9627 ________________________________ In the Matter of :ORDER INSTITUTING A PUBLIC :CEASE-AND-DESIST :PROCEEDING Thomas D. Leaper, CPA, :PURSUANT TO SECTION 21C OF THE William T. Wall, III, CPA, :SECURITIES EXCHANGE ACT OF 1934 Fred S. Flax, CPA, and :AND PUBLIC ADMINISTRATIVE Kellogg & Andelson LLC, :PROCEEDING PURSUANT TO RULE :102(e) OF THE COMMISSION'S RULES :OF PRACTICE, MAKING FINDINGS, :AND IMPOSING A Respondents. :CEASE-AND-DESIST ORDER AND :SANCTIONS _________________________________ I. The Securities and Exchange Commission (the "Commission") deems it appropriate that a cease-and-desist proceeding pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") and public administrative proceeding pursuant to Rule 102(e)(1)(ii) and (iii) of the Commission's Rules of Practice be instituted against Thomas D. Leaper ("Leaper").<(1)> IT IS HEREBY ORDERED that said proceeding be, and hereby is, instituted. The Commission also deems it appropriate that a public administrative proceeding be instituted pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice against William T. Wall, III ("Wall"), Fred S. Flax ("Flax") and Kellogg & Andelson LLC ("Kellogg"). Accordingly, IT IS HEREBY ORDERED that said proceeding be, and hereby is, instituted. <(1)> Rule 102(e) of the Commission's Rules of Practice provides, in pertinent part that: "the Commission may censure a person or 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 . . . (ii) to be lacking in character or integrity or to have engaged in unethical or improper professional conduct; or (iii) to have willfully violated, or willfully aided and abetted the violation of any provision of the Federal securities laws or the rules and regulations thereunder." ======END OF PAGE 1====== II. In anticipation of the institution of this administrative proceeding, Leaper, Wall, Flax and Kellogg (collectively "Respondents") have each submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings herein, except that Respondents admit the jurisdiction of the Commission over them and over the subject matter of this proceeding; and Respondents each consent to the entry of this Order Instituting A Public Cease-And-Desist Proceeding Pursuant to Section 21C of the Exchange Act and Public Administrative Proceeding Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings, and Imposing a Cease-And-Desist Order and Sanctions ("Order") and to the entry of the findings and imposition of the sanctions as set forth below. III. On the basis of this Order and of the Offers of Settlement of Leaper, Wall, Flax and Kellogg the Commission makes the following findings:<(2)> A. Respondents 1. Thomas D. Leaper ("Leaper"), age 42, has an active California Certified Public Accountant ("CPA") license (since 1987) and an inactive New York CPA license (since 1979). In the initial stages of Kellogg's audit of Styles on Video, Inc.'s ("Styles") 1993 financial statements, Leaper was the engagement partner.<(3)> In mid-April 1994, Leaper performed the concurring review. From July 1, 1994 to November 23, 1994, Leaper was Styles' Chief Financial Officer and Chief Operating Officer ("CFO/COO"). From September 1986 through June 1994 and from January 1995 through April 1996, Leaper was employed by Kellogg. Leaper became a Kellogg partner in May 1991, and has been Kellogg's managing partner since May 1996. 2. William T. Wall, III ("Wall"), age 54, has been a California CPA since 1971 and his license is active. Wall succeeded Leaper as engagement partner for Kellogg's audit of Styles' 1993 financial statements, and has been employed by Kellogg since 1969. Wall is an audit partner of Kellogg, and is its primary partner responsible for assuring Kellogg's compliance with independence and other quality control standards of the SEC Practice <(2)> The findings herein are made pursuant to the Offers of Settlement of Leaper, Wall, Flax and Kellogg and are not binding on any other person or entity in this or any other proceeding. <(3)> Although Kellogg is a corporation, this Order uses job titles common to accounting partnerships. Responsibilities of a Kellogg vice president are similar to those of a partner, and responsibilities of Kellogg's president are similar to those of a managing partner. ======END OF PAGE 2====== Section of the American Institute of Certified Public Accountants Division for CPA Firms. 3. Fred S. Flax ("Flax"), age 39, maintains active CPA licenses in California (since 1992) and Maryland (since 1986). He was the engagement manager responsible for Kellogg's audit of Styles' 1993 financial statements. Since leaving Kellogg in October 1995, Flax has been self- employed outside of the financial and accounting professions. 4. Kellogg & Andelson LLC ("Kellogg"), a California corporation, has provided tax, consulting, audit and accounting services since 1939. Kellogg has nine partners and approximately 50 professional employees located in Sherman Oaks, California. Kellogg rendered an audit report on the 1993 financial statements of Styles containing an unqualified opinion thereon. B. The Facts 1. Background Styles common stock has been registered with the Commission since March 29, 1993 pursuant to Section 12(b) of the Exchange Act. Styles developed and marketed computer imaging systems the most common of which was the Styles on Video System (the "Beauty System"), which allows the operator to produce a videotape showing what a salon customer would look like wearing different hairstyles. In 1994, Styles introduced the Tryuson System which allows an optical retail customer to see what he would look like wearing different eyeglasses. To operate a system, the operator must purchase access disks from Styles which operate proprietary software. Contrary to Kellogg's audit report, Styles' financial statements contained material departures from Generally Accepted Accounting Principles ("GAAP"), and Flax, Wall and Leaper failed to perform the audit in accordance with Generally Accepted Auditing Standards ("GAAS"). With respect to Styles' second and third quarters 1994 reported revenue and earnings, Leaper, as Styles' CFO/COO, willfully violated the antifraud and record-keeping provisions, and willfully aided and abetted and caused violations of the reporting, record-keeping and internal control provisions of the federal securities laws. ======END OF PAGE 3====== 2. Fiscal Year 1993 Audit a. Purported Software License For Tryuson Product On December 29, 1993, three days before its fiscal year-end, Styles improperly recognized revenue of $500,000 related to an unconsummated transaction concerning software not yet developed. This transaction was material to Styles' 1993 financial statements, representing 6% of reported revenue and 15% of reported earnings before income taxes. This transaction overstated Styles' actual 1993 revenue by 10%, and understated its actual losses of $700,000 by $500,000. According to Styles' 1993 Form 10-KSB, Styles entered into an agreement in principle with a Netherlands Antilles company ("Licensee") that required Licensee to purchase Tryuson software packages. In return, Styles would grant to Licensee an exclusive license to market the Tryuson System in most of Europe. Styles' 1993 Form 10-KSB indicates that this agreement was not yet consummated. Under GAAP, specifically Statement of Position No. 91-1 ("SOP 91-1"), persuasive evidence of an agreement must exist before revenue from a software license can be properly recognized.<(4)> No such agreement existed. Although a Kellogg audit assistant selected this recorded transaction for routine testing, she failed to attempt to obtain a written agreement. SOP 91-1 further requires that product be shipped before software license revenue is recognized.<(5)> However, Styles' 1993 Form 10-KSB indicated and Flax and Wall knew that the Tryuson software was not yet developed as of fiscal year-end 1993. The auditors failed to test for existence of shipments of Tryuson product. In fact, no software was ever shipped under the agreement in principle. As a corollary test of revenue, Flax and Wall obtained an accounts receivable confirmation response from Licensee that confirmed the receivable. Although GAAS advises that material year-end transactions be tested by confirming information about the transactions underlying the accounts receivable balance, Flax and Wall did not do so.<(6)> They failed to ensure that the revenue related to the accounts receivable balance was recognizable. Moreover, Wall read Styles' draft 1993 Form 10-KSB, which included the above-mentioned disclosures concerning both the agreement in principle with Licensee and the Tryuson software. If an investor had read Styles' Form 10-KSB, he would have concluded that the 1993 revenue and earnings reflected in the financial statements did not include either this <(4)> SOP 91-1, 50. <(5)> SOP 91-1, 32 and 48. <(6)> Codification of Statement on Auditing Standards ("AU")  330.08. ======END OF PAGE 4====== unconsummated transaction or any sales of Tryuson software. Wall failed to ensure that this was in fact the case.<(7)> The financial statements included in Styles' 1993 Form 10-KSB were materially inconsistent with the disclosures contained elsewhere in the Form 10-KSB. b. Tryuson Product Financing Arrangement Recognized As Revenue On December 31, 1993, Styles improperly recognized revenue of $1.5 million from the purported sale of a $1 million Tryuson software license and $500,000 of Tryuson access disks. Actually underlying this amount, however, was a third party's $1 million commitment to finance the completion of the Tryuson project, with the remaining $500,000 simply fictitious. The $1.5 million overstatement was material to Styles' financial statements, representing 18% of reported revenue and 44% of reported earnings before income taxes. This transaction overstated Styles' actual 1993 revenue by 29%, and understated its actual losses of $700,000 by $1.5 million. In late 1993, Styles entered into an oral agreement with a private entity ("Lender"). Lender provided equipment lease financing to Beauty System customers, and wanted to provide financing to future Tryuson System customers. Styles needed seed capital to finish developing and create a marketing plan for the Tryuson System. Under this agreement, Lender would advance $1 million in four equal installments to Styles. When Styles sold a Tryuson System to a customer to whom Lender provided equipment lease financing, Lender would be partially repaid. Styles and Lender agreed that if the Tryuson System leasing program ceased, Styles would apply Lender's payments as advances against future purchases of Beauty Systems. It was improper for Styles to recognize revenue from this arrangement. Styles had done nothing at or prior to December 31, 1993 to earn revenue from Lender's promise to advance $1 million. Under GAAP, revenue must not be recognized before it is earned.<(8)> Specifically, SOP 91-1 requires that persuasive evidence of an agreement exist and product be shipped before revenue from a software license can be properly recognized.<(9)> However, at no time prior to the issuance of Kellogg's audit report was there such a license agreement, and Lender never purchased the Tryuson access disks. The Tryuson software was not fully developed, and Styles did not complete the earnings process necessary to recognize revenue and earnings from the purported license or access disks. The auditors failed to test for existence of a license agreement and shipments of product. Flax and Wall obtained an accounts receivable confirmation response <(7)> AU  550.04. <(8)> Statement of Financial Accounting Concepts No. 5 ("CON 5"), Recognition and Measurement in Financial Statements of Business Enterprises, 83. <(9)> SOP 91-1, 32, 48 and 50. ======END OF PAGE 5====== from Lender confirming that Lender owed Styles $1.25 million at December 31, 1993. However, given the materiality and year-end nature of the transaction, Flax and Wall should have confirmed information about the underlying invoices, including invoice numbers, dates or amounts. Flax and Wall further should have confirmed the nature and terms of the underlying transactions. Had Flax and Wall done so, they likely would have learned that Styles' recognition of the $1.5 million of 1993 revenue and earnings was improper. Under GAAP, revenue must be realized or realizable.<(10)> Other than relying on management's representations, obtaining the accounts receivable confirmation response and observing from Styles' books that Lender had made a $250,000 installment payment, Flax and Wall performed no other procedures to test whether the collectibility of the accounts receivable balance was probable. Flax and Wall failed to obtain sufficient evidence to conclude that the recorded revenue was realizable. Further, Flax and Wall had assessed the overall audit risk at the financial statement level as high. Flax and Wall knew that this $1.5 million of revenue and earnings was material to Styles' financial statements, was recorded at fiscal year-end, and purportedly related to software that was not yet developed. Despite the foregoing, neither Flax nor Wall performed any other substantive audit procedures concerning this transaction. c. Leaper and Kellogg Lacked Independence In late 1993, during the planning of Kellogg's audit of Styles' 1993 financial statements, Leaper was the engagement partner. In mid-February 1994, as audit field work commenced, Styles' CEO discussed with Leaper the possibility of Leaper becoming the CFO/COO of Styles. Leaper believed that his independence was impaired, and properly removed himself as engagement partner. Wall assumed that role. Nevertheless, in mid-April 1994, although Leaper still lacked independence, he performed the concurring partner review. Due to Leaper's impaired independence, Kellogg was not independent when it opined on Styles' 1993 financial statements. In May and June 1994, Leaper and Styles' CEO negotiated terms of Leaper's employment. As of July 1, 1994, Leaper and Styles executed Leaper's employment agreement and Leaper began work as Styles' CFO/COO. <(10)> CON 5, 83. ======END OF PAGE 6====== 3. Leaper's Violations As An Officer of Styles a. Second Quarter 1994 On June 30, 1994, the last day of Styles' second quarter 1994, Styles improperly recorded revenue of $2.1 million from the purported sale of an exclusive license to a Luxembourg company ("European Licensee") to sublicense, distribute and market Styles' products. This overstated quarterly revenue by 137% and materially understated actual losses of $700,000 by $2.1 million. Without this overstatement, Styles would have reported lower revenue than in the prior year period, as well as a loss. For this quarter, Styles reported materially false results of operations in its July 27, 1994 press release and its Form 10-QSB filed with the Commission on August 15, 1994. In addition, Styles falsely reported in its Form 10-QSB that it had collected $1.4 million from the sale of the license. This disclosure lent false credibility to the $2.1 million of reported revenue and earnings. The money was never deposited into a Styles bank account. SOP 91-1 requires that persuasive evidence of an agreement exist before revenue from a software license can be properly recognized.<(11)> No contract was ever executed for this transaction. Leaper knew that the transaction with European Licensee was not yet consummated as of June 30, 1994. Styles' Form 10-QSB, which Leaper reviewed and approved, stated that $720,000 was due from European Licensee upon contract execution. On August 10, 1994, a few days before Styles filed its Form 10-QSB, Styles' CEO told Leaper that he had received $1.4 million from European Licensee in his bank account, and that those funds would be wired to Styles. Leaper relied on and never questioned these representations or the propriety of the CEO personally receiving and holding $1.4 million that purportedly belonged to Styles, nor did he ask the CEO why Styles had not received the funds directly. Further, Leaper never saw any evidence that the CEO had received these funds. GAAP further requires that collectibility be probable before revenue from a software license can be properly recognized.<(12)> With respect to collectibility on arrangements such as that with European Licensee, SOP 91-1 indicates that certain factors should be considered to determine whether the licensee has the ability to pay the license fee. Specifically stated factors include the licensee's operating history, the newness of the product or marketing channel, and whether the licensee is new, undercapitalized, or in financial difficulty.<(13)> Leaper did not know enough about European Licensee to know its operating history, or to know if it had an operating history. Leaper knew that some of Styles' products and marketing channels were new. Finally, Leaper knew that Styles' CEO had not <(11)> SOP 91-1, 50. <(12)> SOP 91-1, 32 through 34. <(13)> SOP 91-1, 58. ======END OF PAGE 7====== transferred the $1.4 million to Styles,<(14)> and Leaper was not aware of any payments to Styles from European Licensee. Thus, collectibility of the receivable due from European Licensee was sufficiently uncertain that recognizing revenue of $2.1 million was a material departure from GAAP. At the time Styles filed its second quarter 1994 Form 10-QSB, Leaper had no information that supported the CEO's representation that this transaction was consummated. Although in late June 1994 Leaper saw a draft agreement, he never saw an executed agreement. No payments had been made that might evidence the possibility of an executed contract. As far as Leaper knew, Styles had never received payment from European Licensee and he had evidence that collectibility was not probable. Despite these facts, Leaper did not question the propriety of Styles' accounting. Based solely on the CEO's representations and in the face of contrary evidence, Leaper permitted Styles to record and report $2.1 million of revenue and earnings. Further, although he knew that Styles had not received the $1.4 million, he permitted Styles to falsely disclose in its second quarter Form 10-QSB that it had received these funds. b. Third Quarter 1994 For the third quarter ended September 30, 1994, Styles improperly recorded revenue of $2.5 million in connection with the purported sale of the Tryuson System business to Lender. This overstated quarterly revenue by 166% and materially understated actual losses of $900,000 by $2.5 million. Without this revenue overstatement, Styles would have reported a loss. For this quarter, Styles reported materially false results of operations in its November 7, 1994 press release and in its Form 10-QSB filed with the Commission on November 25, 1994. In November 1994, Lender and Styles orally agreed that Lender would purchase the entire Tryuson business. Lender would pay $2.5 million by nonrecourse promissory note for the Tryuson business. The promissory note would be payable from net cash flow from the Tryuson business, and secured by the Tryuson software source codes (which would be transferred to Lender at closing of this transaction). To consummate this transaction, Styles was required to satisfy several significant conditions, none of which were ever met. Under GAAP, revenue must not be recognized before it is earned.<(15)> This transaction was never consummated, and Styles' <(14)> On November 23, 1994, Styles' CEO directed Leaper to include in the company's third quarter 1994 Form 10-QSB cash balance (as of September 30, 1994) this $1.4 million which still had not been deposited into a Styles bank account. As a result, Leaper declined to file the Form 10-QSB and immediately resigned. Leaper did, however, agree with the improper inclusion of $2.5 million of revenue and earnings in the third quarter 1994 Form 10-QSB. See paragraph b. entitled "Third Quarter 1994" which follows. <(15)> CON 5, 83. ======END OF PAGE 8====== revenue recognition was a material departure from GAAP. Nevertheless, Leaper, based solely on the CEO's representations to him that this transaction was complete: (1) drafted a press release describing the transaction; (2) on October 29, 1994, directed Styles' controller to record this transaction as a September 1994 (third quarter 1994) entry; (3) permitted a quarterly earnings release to be disseminated which included this $2.5 million of revenue and earnings; and (4) allowed the inclusion of this $2.5 million in Styles' third quarter 1994 Form 10-QSB. With respect to this transaction, Leaper had no discussions with anyone other than Styles' CEO. He never questioned the CEO's representations concerning this material transaction or the propriety of Styles recognizing this $2.5 million of revenue and earnings. C. Applicable Law 1. Antifraud Provisions: Section 10(b) of the Exchange Act and Rule 10b-5 Thereunder Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit fraudulent conduct "in connection with the purchase or sale of any security." Under these provisions, the fraudulent conduct must concern a material fact. A fact is material if there is a substantial likelihood that a reasonable investor would consider it important to an investment decision. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Scienter is also a required element for violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. See Aaron v. SEC, 446 U.S. 680, 701-02 (1980). Scienter is the "intent to deceive, manipulate or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12 (1976); Aaron, 446 U.S. at 626 n.5. In the Ninth Circuit, recklessness satisfies the scienter requirement. See Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990), cert. denied, 499 U.S. 976 (1991). Recklessness is "an extreme departure from the standards of ordinary care, and which presents a danger of misleading [investors] that is either known to the defendant or is so obvious that the actor must have been aware of it." Hollinger, 914 F.2d at 1569. a. Materiality For its second quarter 1994, Styles falsely reported in its July 27, 1994 press release and in its Form 10-QSB filed with the Commission on August 15, 1994 revenue and earnings of $2.1 million related to a purported sale of a software license. Styles' second quarter 1994 revenue was overstated by 137% and losses of $700,000 were understated by $2.1 million. In addition, Styles falsely stated in its Form 10-QSB that it had collected $1.4 million from the sale of the license, lending false credibility to the $2.1 million of reported revenue and earnings. For its third quarter 1994, Styles falsely reported in its November 7, 1994 press release and in its Form 10-QSB filed with the Commission on November 25, 1994 revenue and earnings of $2.5 million related to a purported sale of the Tryuson System business. As a result of these misrepresentations, Styles' third quarter 1994 revenue was overstated by 166% ======END OF PAGE 9====== and losses of $900,000 were understated by $2.5 million. Given the magnitude of these misrepresentations, reasonable investors making a decision to invest in Styles would consider it important that its second and third quarters 1994 results of operations were overstated as described above. b. Leaper Acted With Scienter As to Styles' second quarter 1994 false reporting, Leaper knew, or was reckless in not knowing, that the software license transaction from which Styles improperly recognized and reported revenue and earnings of $2.1 million was not consummated nor was its collectibility probable. Leaper knew, or was reckless in not knowing, that Styles' disclosure in its second quarter 1994 Form 10-QSB that it had received $1.4 million in connection with the $2.1 million of revenue and earnings was false. As to Styles' third quarter 1994 false reporting, Leaper knew, or was reckless in not knowing, that the purported sale of the Tryuson System business from which Styles improperly recognized revenue and earnings of $2.5 million was not a consummated transaction. As Styles' CFO, Leaper knew, or was reckless in not knowing, that Styles' recognition of revenue and earnings from these transactions was a material departure from GAAP. Nevertheless, Leaper permitted Styles' material misrepresentations concerning these transactions. Leaper, at a minimum, was reckless in not verifying, beyond receiving Styles' CEO's assurances, that these transactions were actually consummated, the earnings process complete, and the revenue collectible as required by GAAP. Leaper acted with scienter at the time he committed the acts described above, and accordingly, willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. 2. Reporting Provisions: Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 Thereunder Section 13(a) of the Exchange Act and Rule 13a-13 thereunder require issuers with securities registered pursuant to Section 12 of the Exchange Act, such as Styles, to file with the Commission quarterly reports. The filings must be accurate. SEC v. Falstaff Brewing Corp., 629 F.2d 62, 72 (D.C. Cir. 1980), cert. denied, 449 U.S. 1012 (1980); SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). Rule 12b-20 under the Exchange Act similarly requires that these reports contain any material information necessary to make the required statements made in the reports not misleading. Scienter is not required to establish a violation of Section 13(a). See SEC v. Savoy Indus., Inc., 587 F.2d at 1167. Styles violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder by: (1) overstating revenue and understating losses in its Forms 10-QSB for its second and third quarters 1994; and (2) in its second quarter 1994 Form 10-QSB, falsely stating that it had received a $1.4 million cash collection when in fact it had not. As discussed above, such false and misleading information was material. As Styles' CFO, Leaper was responsible for assuring that Styles ======END OF PAGE 10====== properly disclosed financial information, and properly reported its results of operations and financial condition. Nevertheless, Leaper approved Styles' second quarter 1994 Form 10-QSB which included the false revenue and earnings of $2.1 million from the purported software license, and the false and misleading disclosure concerning the purported $1.4 million cash receipt. For the third quarter 1994, Leaper directed Styles' controller to record the $2.5 million unconsummated transaction as revenue and earnings, which he knew would be reported in Styles' Form 10-QSB. Leaper knew, or was reckless in not knowing, that reporting these transactions was improper. Leaper caused Styles' violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. Moreover, an individual is liable for aiding and abetting a securities law violation where: (1) a primary violation occurred; (2) the alleged aider and abettor had knowledge of the improper activity and his role in it; and (3) the alleged aider and abettor knowingly rendered substantial assistance in the violation. See Hauser v. Farrell, 14 F.3d 1338, 1343 (9th Cir. 1994); Armstrong v. McAlpin, 699 F.2d 79 (2d Cir. 1983). As discussed above, Styles violated Section 13(a) and Rules 12b-20 and 13a-13 thereunder. Leaper, as Styles' CFO, was responsible for reviewing Styles' disclosures. Leaper was responsible for the fair presentation of Styles' financial statements in conformity with GAAP. Thus, Leaper willfully aided and abetted Styles' violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. 3. Record-Keeping Provisions: Section 13(b)(2)(A) of the Exchange Act and Rule 13b2-1 Thereunder Section 13(b)(2)(A) of the Exchange Act requires every issuer that has securities registered pursuant to Section 12 of the Exchange Act such as Styles, to "make and keep books, records, and accounts, which in reasonable detail, accurately and fairly reflect the transactions . . . of the issuer." No showing of scienter is required. SEC v. World Wide Coin Inv. Ltd., 567 F. Supp. 724, 749, 751 (N.D. Ga. 1983). Rule 13b2-1 under Section 13(b)(2)(A) of the Exchange Act provides that "no person shall, directly or indirectly, falsify or cause to be falsified, any book, record or account subject to Section 13(b)(2)(A)." Styles violated Section 13(b)(2)(A) in that its books, records and accounts inaccurately reflected its transactions. Styles' books and records for its second and third quarters 1994 improperly reflected revenue and earnings not earned. Leaper, as Styles' CFO, was responsible for assuring that Styles maintained accurate records and made financial reports that fairly presented Styles' transactions. Leaper supervised Styles' accounting activities, and was a CPA. Leaper permitted Styles to improperly record revenue and earnings from the second quarter 1994 $2.1 million purported software license. As to the third quarter of 1994, Leaper directed Styles' controller to record the $2.5 million unconsummated transaction as revenue and earnings. Leaper failed to keep accurate books and records for Styles. Leaper willfully aided and abetted and caused Styles' violations of the record- ======END OF PAGE 11====== keeping provisions of Section 13(b)(2)(A) of the Exchange Act. Further, Leaper willfully violated Rule 13b2-1 under the Exchange Act, which provides that no person shall falsify or cause to be falsified any book, record or account subject to Section 13(b)(2)(A). 4. Internal Control Provisions: Section 13(b)(2)(B) of the Exchange Act The internal control provisions of Section 13(b)(2)(B) of the Exchange Act require issuers with securities registered pursuant to Section 12 of the Exchange Act, such as Styles, to devise and maintain a system of internal accounting controls sufficient to reasonably assure, among other things, that transactions are recorded as necessary to permit preparation of financial statements in conformity with GAAP. Scienter is not required to prove a violation of this section. See SEC v. World-Wide Coin Inv., Ltd., 567 F. Supp. at 749, 751. Styles lacked the required internal accounting controls necessary to properly record certain types of transactions in its books and records and report in its financial statements in conformity with GAAP. Specifically, Styles had inadequate internal controls to assure that it did not recognize revenue and earnings relating to: (1) unconsummated transactions; (2) sales of software not shipped; and (3) transactions for which collectibility was not probable. Leaper, as Styles' CFO, was primarily responsible for devising and implementing Styles' system of internal accounting controls. Leaper, however, did not develop internal controls that would assure that Styles did not improperly recognize revenue and earnings. Leaper, therefore, willfully aided and abetted and caused Styles' violations of Section 13(b)(2)(B) of the Exchange Act. 5. Willful Violations And Willful Aiding And Abetting Violations Of The Federal Securities Laws Or The Rules And Regulations Thereunder: Rule 102(e)(1)(iii) of the Commission's Rules of Practice Rule 102(e)(1)(iii) of the Commission's Rules of Practice provides, among other things, that the Commission may deny, for a period of time or permanently, the privilege of appearing or practicing before the Commission to any person who is found by the Commission to have willfully violated, or willfully aided and abetted any violation of any provision of the federal securities laws. As discussed above, Leaper, a CPA, willfully violated the antifraud and record-keeping provisions, and willfully aided and abetted Styles' violations of the reporting, record-keeping and internal control provisions of the federal securities laws. 6. Improper Professional Conduct: Rule 102(e)(1)(ii) of the Commission's Rules of Practice Flax, Wall, Leaper and Kellogg engaged in improper professional conduct during Kellogg's audit of Styles' 1993 financial statements. Flax and Wall failed to adhere to four of the ten basic standards of GAAS. Specifically, Flax (engagement manager) and Wall (engagement partner) failed to: (1) adequately plan the audit work and properly supervise the ======END OF PAGE 12====== assistants; (2) obtain sufficient competent evidential matter to afford a reasonable basis for Kellogg's opinion; (3) exercise due professional care; and (4) render an accurate audit report. Leaper did not comply with GAAS when he failed to maintain his independence yet performed the concurring partner review. Likewise, Kellogg, through Leaper, was not independent when Leaper failed to maintain his independence. a. Flax and Wall Failed to Adequately Plan and Supervise the Audit, and Properly Consider Audit Risk The first standard of field work of GAAS requires that audit work be adequately planned and properly supervised. In planning the audit, the auditor should, among other things: (1) obtain a level of knowledge of the client's business to enable him to plan and perform the audit in accordance with GAAS; (2) assess audit risk; and (3) prepare a written audit program. AU  311.01-.08 and 312.02. "Audit risk is the risk that the auditor may unknowingly fail to appropriately modify his opinion on financial statements that are materially misstated." AU  312.02. When the auditor concludes that there is significant risk at the financial statement level, as Flax and Wall did in this audit, "the auditor requires more or different evidence than he would to support material transactions than would be the case in the absence of such risk. For example, the auditor may perform additional procedures to determine that sales are properly recorded . . . Transactions that are both large and unusual, particularly at year-end, should be selected for testing." AU  316.20. Further, the auditor should plan and perform the audit with an attitude of professional skepticism. AU  316.16, 18 and .19. "The auditor neither assumes that management is dishonest nor assumes unquestioned honesty." AU  316.16. Flax and Wall knew that Styles had recorded material year-end revenue transactions, and they assessed risk at the financial statement level as high. Flax and Wall should have supplemented the audit programs to include specific procedures with respect to these purported year-end license agreements. If Flax and Wall had properly supervised the audit, the audit assistants would have been informed of their responsibilities and the objectives of the procedures that they were to perform. AU  311.12. Neither Flax nor Wall planned or directed that any work be performed focused on significant revenue transactions recorded by Styles at or near year-end. GAAS indicates that with transactions such as the two 1993 transactions described herein, the auditor should confirm the terms of the sale. AU  330.08. Neither Flax nor Wall contemplated modifying Kellogg's standard accounts receivable confirmation request to confirm the nature and terms of the transaction(s) underlying the receivables. ======END OF PAGE 13====== b. Flax and Wall Failed to Obtain Sufficient Competent Evidence In conducting an audit, an auditor must obtain sufficient competent evidential matter through inspection, inquiries and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. AU  326.01. As with planning, the auditor must maintain an attitude of professional skepticism when performing audit procedures and gathering evidence. AU  316.16 and .21. For example, GAAS warns the auditor against relying too heavily on management's representations when he is obtaining the basis for his opinion on the financial statements. AU  333.02 and 326.19a. When selecting particular substantive tests, an auditor must consider various factors, including the relative risk that irregularities would be material to the financial statements. AU  326.11. The auditor is responsible for searching for material irregularities, including intentional falsification or alteration of accounting records and supporting documents. AU  316.03 and .05. The auditor must have stronger grounds to sustain an opinion with respect to those items that are relatively more important and that have greater possibilities of material misstatement. AU  150.04. Flax and Wall assessed the audit risk as high, and they knew that the two 1993 transactions described herein were material and recorded at or near year-end. Nevertheless, Flax and Wall failed to properly consider risk, maintain a skeptical attitude and assure that sufficient competent evidence was obtained during the audit with respect to these purported transactions. No executed agreements existed, the product which was purportedly the subject of these transactions was not yet developed, and Flax and Wall failed to confirm the nature and terms of the purported transactions with anyone other than Styles' CEO. c. Wall Failed to Properly Consider Other Information in Styles' 1993 Form 10-KSB Under GAAS, the auditor of the financial statements of a public client filing a periodic report with the Commission must read the other information contained in that periodic report. The auditor is required to consider whether such information, or the manner of its presentation, is materially inconsistent with information, or the manner of its presentation, appearing in the financial statements. If the auditor concludes that there is a material inconsistency, he should determine whether the financial statements, his report, or both require revision. AU  550.04. As described herein, disclosures in Styles' 1993 Form 10-KSB concerning the Tryuson software and the agreement in principle with Licensee were materially inconsistent with the financial statements. These discrepancies between the other information in Styles' 1993 Form 10-KSB and the financial statements were material. Wall failed to comply with GAAS. ======END OF PAGE 14====== d. Flax and Wall Failed to Maintain an Attitude of Professional Skepticism The auditor should plan and perform an audit with an attitude of professional skepticism. The auditor needs to objectively evaluate the conditions he observes and evidence he obtains during his audit to determine whether the financial statements are free of material misstatements. AU  316.16. As described above, neither Flax nor Wall demonstrated an attitude of skepticism during Kellogg's audit of Styles' financial statements. They overrelied on management's representations. e. Flax and Wall Caused Kellogg to Fail to Render an Accurate Audit Report An auditor's report must express an opinion on the financial statements taken as a whole and must contain a clear indication of the character of the auditor's work. AU  504.01. The auditor can determine that he is able to express an unqualified opinion only when he has concluded that the financial statements present fairly, in all material respects, the client's financial position, results of operations, and cash flows in conformity with GAAP, and he has conducted his audit in accordance with GAAS. AU  508.07. Kellogg falsely stated in its audit report on Styles' 1993 financial statements that the financial statements were in conformity with GAAP and that its audit was performed in accordance with GAAS. Styles' 1993 financial statements contained material departures from GAAP and Kellogg failed to perform its audit in accordance with GAAS. Flax and Wall caused Kellogg to fail to render an accurate audit report. f. Flax and Wall Failed to Exercise Due Professional Care Auditors must exercise due professional care in performing the audit and preparing the report. AU  230.01. Exercise of due care requires a critical review at every level of supervision of the work done and the judgment exercised by those assisting in the audit. AU  230.02. The matter of due care concerns what the auditor does and how well he does it. AU  230.04. Flax and Wall failed to exercise due professional care by failing to: (1) adequately plan and properly supervise the audit, and properly consider the audit risk that the financial statements were materially misstated; (2) obtain sufficient competent evidence to support the assertions in the financial statements by, among other things, substituting representations from management for the application of auditing procedures necessary to afford a reasonable basis for the opinion on the financial statements; (3) maintain an attitude of professional skepticism; and (4) render an accurate audit report. ======END OF PAGE 15====== g. Leaper and Kellogg Failed to Maintain Independence In all matters relating to the assignment, an auditor must maintain an independence in mental attitude. AU  220.01; Rule 210.2-01(b) of Regulation S-X. This standard requires that the auditor be without bias with respect to the client since otherwise he would lack the impartiality required for which his findings depend. AU  220.02. In late 1993, while planning Kellogg's audit, Leaper was the engagement partner. In mid- February 1994, as audit field work commenced, Styles' CEO discussed with Leaper the possibility of Leaper becoming the CFO/COO of Styles. Leaper believed that his independence was impaired, and properly removed himself as engagement partner. Yet shortly thereafter, although he still lacked independence, Leaper performed the concurring review. Due to Leaper's impaired independence, Kellogg was not independent when it opined on Styles' 1993 financial statements. In May and June 1994, Leaper and Styles' CEO negotiated the terms of Leaper's employment. As of July 1, 1994, Leaper and Styles executed Leaper's employment agreement and Leaper began work as Styles' CFO/COO. D. Conclusion Based on the foregoing, the Commission finds that: (1) Leaper willfully violated Section 10(b) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder, and willfully aided and abetted and caused violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder; and (2) Flax, Wall, Leaper and Kellogg engaged in improper professional conduct within the meaning of Rule 102(e)(1)(ii) of the Commission's Rules of Practice. IV. Based on the foregoing, the Commission deems it appropriate to accept the Offers of Settlement of Kellogg, Leaper, Wall, and Flax and accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the Exchange Act, that Leaper cease and desist from committing or causing any violation and any future violation of Section 10(b) of the Exchange Act and Rules 10b-5 and 13b2-1 thereunder, and from causing any violation and any future violation of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder. ======END OF PAGE 16====== IT IS HEREBY FURTHER ORDERED, pursuant to Rules 102(e)(1)(ii) and (iii) of the Commission's Rules of Practice, that, effective immediately: A. Leaper is denied the privilege of appearing or practicing before the Commission as an accountant. B. After five years from the date of this Order, Leaper may apply to the Commission by submitting an application to the Office of the Chief Accountant which requests permission to resume appearing or practicing before the Commission as: 1. a preparer or reviewer, or a person responsible for the preparation or review, of financial statements of a public company to be filed with the Commission upon submission of an application satisfactory to the Commission in which Leaper undertakes that, in his practice before the Commission, his work will be reviewed by the independent audit committee of the company for which he works or in some other manner acceptable to the Commission; 2. an independent accountant upon submission of an application containing a showing satisfactory to the Commission that: a. Leaper, 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 appears or practices before the Commission as an independent accountant; b. Leaper 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 c. Leaper 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 any request or application by Leaper to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Leaper's character, integrity, professional conduct, or qualifications to appear or practice before the Commission. ======END OF PAGE 17====== IT IS HEREBY FURTHER ORDERED, pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice, that, effective immediately: A. Wall and Flax are denied the privilege of appearing or practicing before the Commission as accountants. B. After three years from the date of this Order, Wall or Flax may apply to the Commission by submitting an application to the Office of the Chief Accountant which requests permission to resume appearing or practicing before the Commission as: 1. a preparer or reviewer, or a person responsible for the preparation or review, of financial statements of a public company to be filed with the Commission upon submission of an application satisfactory to the Commission in which Wall or Flax undertakes that, in his practice before the Commission, his work will be reviewed by the independent audit committee of the company for which he works or in some other manner acceptable to the Commission; 2. an independent accountant upon submission of an application containing a showing satisfactory to the Commission that: a. Wall or Flax, 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 appears or practices before the Commission as an independent accountant; b. Wall or Flax 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 c. Wall or Flax 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 any request or application by Wall or Flax to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Wall's or Flax's character, integrity, professional conduct, or qualifications to appear or practice before the Commission. ======END OF PAGE 18====== IT IS HEREBY FURTHER ORDERED, pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice, that, effective immediately: A. Kellogg is hereby censured; B. Kellogg will retain an Independent Reviewer, not unacceptable to the Chief Accountant of the Commission, to review the firm's independence quality controls in its accounting and auditing practice; 1. Within thirty (30) days of the issuance of this Order, the Independent Reviewer will both review the firm's independence quality controls and make recommendations for changes. Within sixty (60) days after receiving the Independent Reviewer's review and recommendations, Kellogg will implement all recommendations made by the Independent Reviewer; 2. Within sixty (60) days after implementation of the Independent Reviewer's recommendations, the Independent Reviewer will report to the Chief Accountant of the Commission on its initial review and on Kellogg's subsequent implementation of the Independent Reviewer's recommendations; and 3. Kellogg will provide a copy of this Order and a copy of the Independent Reviewer's report to the peer reviewer for use in Kellogg's 1999 peer review. By the Commission. Jonathan G. Katz Secretary ======END OF PAGE 19======