UNITED STATES OF AMERICA
In the Matter of
|ORDER INSTITUTING PUBLICADMINISTRATIVE AND CEASE- AND-DESIST PROCEEDINGS PURSUANT TO SECTION 8A OF THE SECURITIES ACT OF 1933, SECTION 21C OF THE SECURITIES EXCHANGE ACT OF 1934, AND RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS AND A CEASE-AND-DESIST ORDER|
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings and cease-and-desist proceedings be, and hereby are, instituted against Levine, Hughes, and Mithuen ("LHM" or "Respondent"), pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Section 21C of the Securities Exchange Act of 1934 ("Exchange Act"), and Rule 102(e)(1)(iii) of the Commission's Rules of Practice.1
In anticipation of the institution of these proceedings, LHM has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over it and the subject matter of these proceedings, which are admitted, LHM consents to the entry of this Order Instituting Public Administrative and Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933, Section 21C of the Securities Exchange Act of 1934, and Rule 102(e) of the Commission's Rules of Practice, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order ("Order"), as set forth below.
On the basis of this Order and Respondent's Offer, the Commission finds2 that:
Levine, Hughes, and Mithuen, Inc. ("LHM") is a Denver, Colorado accounting firm that served as auditors for Sport-Haley, Inc. ("Sport-Haley") from 1992 until Sport-Haley dismissed the firm in July 2000.
1. Sport-Haley is a Denver, Colorado company that designs, markets, and contracts for the manufacture of golf apparel and outerwear. Sport-Haley's stock is registered with the Commission pursuant to Section 15(d) of the Exchange Act and is quoted on the NASDAQ National Market System.
2. Beginning no later than early 1998, Sport-Haley's computerized inventory system began improperly accumulating WIP inventory. As a result of the improper accrual, Sport-Haley's WIP inventory balance ballooned to $1.7 million during its 1998 fiscal year. The 1998 WIP inventory accounted for 9.5 percent of Sport-Haley's total inventory and had increased by more than 900 percent from the prior year. Despite the fact that the 1998 WIP inventory balance was substantially higher than the expected $200,000 to $500,000 balance, Sport-Haley never physically counted the company's WIP inventory in fiscal 1998 and failed to take any reasonable steps to verify the amount of WIP inventory during the company's 1998 fiscal year. LHM did not perform sufficient audit procedures on Sport-Haley's WIP inventory. As a result, LHM recklessly allowed Sport-Haley to include materially overstated WIP inventory in its 1998 financial statements. Moreover, LHM issued an audit report containing an unqualified opinion on Sport-Haley's 1998 financial statements.
3. During the audit of Sport-Haley's financial statements for the fiscal year ended June 30, 1999, Sport-Haley informed LHM that WIP inventory had reached approximately $2.1 million. The LHM audit partner met with Sport-Haley's officers during the 1999 audit to determine how to properly ascertain and ultimately adjust the WIP inventory account for the company's 1999 year-end financial statements. LHM participated in creating a solution that minimized the impact on the company's gross margin, kept the 1998 financial statements intact, and ratably eliminated the overstatement during the course of the 2000 fiscal year.
4. With LHM's approval, Sport-Haley estimated the proper amount of WIP inventory as of June 30, 1999 to be approximately $370,000, purportedly leaving an overstated balance of approximately $1.7 million. The company then wrote off approximately $560,000 of the $1.7 million to cost of goods sold. Sport-Haley moved the remaining $1.2 million of the overstated inventory balances to a new inventory account that was to be amortized over the course of the 2000 fiscal year, at approximately $100,000 monthly. These entries lacked sufficient accounting basis. LHM failed to perform sufficient audit procedures to verify how much WIP inventory should be properly recorded in the company's 1999 year-end financial statements. Moreover, LHM knew or was reckless in not knowing that the WIP inventory adjustments made by Sport-Haley were not in accordance with generally accepted accounting principles and were misleading.
5. Sport-Haley did not disclose the WIP inventory error or explain the company's measures to adjust the financial statements for the WIP inventory error in its 1999 Form 10-K or Forms 10-Q for the company's first three quarters of its 2000 fiscal year. Even though LHM knew or was reckless in not knowing of the overstated WIP inventory account balance in 1999, LHM issued an audit report containing an unqualified opinion on Sport-Haley's 1999 financial statements. LHM also failed to notify Sport-Haley's audit committee that Sport-Haley's 1999 financial statements and quarterly reports for the first three quarters of its 2000 fiscal year were materially misstated. As a result of the company's improper accounting for the WIP inventory error, Sport-Haley filed its Form 10-K for the fiscal year ended June 30, 1999, including financial statements that materially overstated WIP inventory by over $1.2 million or 10 percent of total inventory.
6. Prior to July 1, 1997, Sport-Haley began materially understating expenses related to product design, tradeshows, logo disks, property taxes and advertising by improperly deferring these costs as prepaid and fixed assets. However, Sport-Haley's capitalization of several prepaid and fixed assets was not in accordance with generally accepted accounting principles. LHM's audit workpapers contained no accounting basis for Sport-Haley's accounting treatment. LHM recklessly allowed Sport-Haley to improperly capitalize period costs and caused Sport-Haley materially to overstate its income by $164,000 or four percent of pretax income in its 1998 Form 10-K for the fiscal year ended June 30, 1998, and $159,000 or 11.5 percent in its 1999 Form 10-K for the fiscal year ended June 30, 1999.
7. In a May 28, 1999 press release, Sport-Haley announced it was discontinuing its headwear product line at the end of its 1999 fiscal year and that the sale of headwear equipment from the discontinued operations would result in an estimated $160,000 loss. After issuing the May 1999 press release, Sport-Haley revised the estimated loss on disposal of headwear equipment to $298,000 and recorded the loss in its books. Before the audit fieldwork was completed, the company reversed $206,000 of the loss without sufficient accounting support.
8. The LHM personnel who reviewed audit procedures on Sport-Haley's discontinued headwear operations failed to perform or direct others to perform sufficient procedures to substantiate the estimated loss on disposal of headwear equipment. Although LHM had sufficient information to know Sport-Haley anticipated significantly larger losses, it recklessly allowed Sport-Haley to record only $92,000 loss related to the headwear equipment in its 1999 Form 10-K filed with the Commission. By failing to recognize the estimated loss on disposal of headwear equipment in conformity with generally accepted accounting principles, Sport-Haley understated its 1999 pretax loss on disposal of assets by $206,000 or 69.1 percent of pretax loss.Document Destruction
9. On November 13, 2000, the Commission staff sent a letter to LHM requesting that it produce documents related to LHM's audits of Sport-Haley. At the time LHM received the staff's request for documents, LHM was in the process of conducting an internal review of the 1999 Sport-Haley audit workpapers ("November 2000 review"). As a result of this November 2000 review, LHM personnel added information to its workpapers concerning the accounting areas Sport-Haley restated including WIP inventory, discontinued operations, and prepaid expenses. Moreover, LHM partners and staff improperly altered some of the original audit workpapers during the November 2000 review by adding information to the workpapers. In addition, during the November 2000 review, an LHM staff accountant disposed of Sport-Haley documents that remained in LHM's office after the firm conducted the 1999 audit. Finally, after the November 2000 review, one of LHM's audit review partners destroyed review notes that had been created as part of LHM's review of past Sport-Haley audits.
10. Section 17(a) of the Securities Act makes it unlawful to employ any device, scheme, or artifice to defraud in the offer or sale of any securities. Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit a person, in connection with the purchase or sale of a security, from making an untrue statement of a material fact or from omitting to state a material fact necessary to make statements made, in light of the circumstances under which they were made, not misleading. To establish violations of Section 17(a)(1) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder ("the antifraud provisions"), a defendant must act with scienter, Aaron v. SEC, 446 U.S. 680, 695, 701-02 (1980), which the Supreme Court has defined as "a mental state embracing intent to deceive, manipulate, or defraud," Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). Scienter may be established by reckless conduct. Hackbart v. Holmes, 675 F.2d 1114, 1117 (10th Cir. 1982); Anixter v. Home-Stake Production, 77 F.3d 1215, 1225-1227 (10th Cir. 1996) (violation of antifraud provisions to prepare and certify financial statements auditor knows or is reckless in not knowing, are false).
11. As a result of actions taken by LHM described above, during Sport-Haley's 1998 and 1999 fiscal years, LHM caused Sport-Haley to file quarterly and annual reports with the Commission that were materially misstated and that misrepresented Sport-Haley's financial condition and results of operations. LHM knew or were reckless in not knowing that certain financial accounting and reporting practices were improper and assisted in carrying out those practices. By the conduct described above, LHM committed and caused violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
12. Section 15(d) of the Exchange Act and Rules 15d-1 and 15d-13 thereunder require issuers with securities registered under the Securities Act to file quarterly and annual reports with the Commission and to keep this information current. The obligation to file such reports embodies the requirement that they be true and correct. See, e.g., SEC v. Savoy Indus., Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). In addition, Rule 12b-20 requires that reports contain such further material information as may be necessary to make the required statements, in light of the circumstances under which they were made, not misleading. No showing of scienter is required to establish a violation of these provisions. Savoy Indus., 587 F.2d at 1167.
13. As discussed above, during Sport-Haley's 1998 and 1999 fiscal years, Sport-Haley filed, and LHM caused Sport-Haley to file, false and misleading quarterly and annual reports with the Commission that misrepresented the financial results of Sport-Haley, materially misstating income, WIP inventory, period costs, and discontinued headwear operations. By the conduct described above, LHM caused Sport-Haley's violations of Section 15(d) of the Exchange Act and Rules 12b-20, 15d-1 and 15d-13 thereunder.
14. Based on the foregoing, the Commission finds that LHM willfully violated and caused violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and LHM willfully aided and abetted and caused violations of Section 15(d) of the Exchange Act and Rules 12b-20, 15d-1 and 15d-13 promulgated thereunder.
LHM undertakes to:
(a) promptly establish and maintain policies and procedures to preserve working papers intact following the completion of auditing and other engagements and also during the course of, and following the conclusion of, any post-audit review, as well as enhance policies for the supervision of lower-level accountants and assistants. Within three months of the date of this Order, LHM shall certify in writing to the Commission that such policies and procedures have been established and implemented; and
(b) after LHM certifies to the Commission that the policies and procedures set forth in paragraph (a), above, have been established and implemented, to retain, at LHM's expense, an independent consultant or consultants (the "Consultant") not unacceptable to the staff of the Commission. LHM shall require the Consultant to: (1) confirm that LHM has disseminated firm-wide, the policies and procedures referenced in paragraph (a), above; (2) conduct a review of a one-year period beginning three months from the date of this Order (the "Review Period") of LHM's compliance with the policies and procedures referenced in paragraph (a); and (3) submit a report to the Commission's staff, within 30 days of the review, detailing the results of this review.
(c) In addition, LHM shall require the Consultant to enter into an agreement that provides that for the period of engagement and for a period of two years from completion of the engagement, the Consultant shall not enter into any employment, consultant, attorney-client, auditing or other professional relationship with LHM, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such. The agreement will also provide that the Consultant will require that any firm with which he/she is affiliated or of which he/she is a member, and any person engaged to assist the Consultant in performance of his/her duties under this Order shall not, without prior written consent of the Commission's staff, enter into any employment, consultant, attorney-client, auditing or other professional relationship with LHM, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such for the period of the engagement and for a period of two years after the engagement.
(d) In determining whether to accept the Offer, the Commission has considered the undertakings set forth in paragraphs (a) through (c), above.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in the Offers of Respondent LHM.
Accordingly, it is hereby ORDERED, effective immediately, that:
A. LHM shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder; and from causing any violations and any future violations of Section 15(d) of the Exchange Act, and Rules 12b-20, 15d-1 and 15d-13 promulgated thereunder;
B. LHM is denied the privilege of appearing or practicing before the Commission as an accounting firm.
C. After three years from the date of this order, LHM may request that the Commission consider its reinstatement.
D. LHM may request that the Commission consider its reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as an independent accounting firm. Such an application must satisfy the Commission that:
(a) LHM is registered with the Public Company Accounting Oversight Board ("Board") in accordance with the Sarbanes-Oxley Act of 2002, and such registration continues to be effective;
(b) LHM has been inspected by the Board and that inspection did not identify any criticisms of or potential defects in LHM's quality control system that would indicate that LHM personnel will not receive appropriate supervision or, if the Board has not conducted an inspection, has received an unqualified report relating to the firm's, most recent peer review conducted in accordance with the guidelines adopted by the former SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms or an organization providing equivalent oversight and quality control functions;
(c) LHM has resolved all disciplinary issues with the Board, and has complied with all terms and conditions of any sanctions imposed by the Board (other than reinstatement by the Commission); and
(d) LHM acknowledges its responsibility, as long as LHM appears or practices before the Commission as an independent accounting firm, to comply with all requirements of the Commission and the Board, including, but not limited to, all requirements relating to registration, inspections, concurring partner reviews and quality control standards.
E. The Commission will consider an application by Respondent to resume appearing or practicing before the Commission provided that its state CPA licenses are current and it has resolved all other disciplinary issues with the applicable state boards of accountancy. However, if state licensure is dependant on reinstatement by the Commission, the Commission will consider an application on its other merits. The Commission's review may include consideration of, in addition to the matters referenced above, any other matters relating to Respondent's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
The Commission may...deny, temporarily or permanently, the privilege of appearing or practicing before it in any way to any person who is found…to have willfully violated, or willfully aided and abetted the violation of any provision of the Federal securities laws and the rules or regulations thereunder.
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