UNITED STATES OF AMERICA
SECURITIES EXCHANGE ACT OF 1934
ACCOUNTING AND AUDITING ENFORCEMENT
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings against William L. Clancy pursuant to Rule 102(e)1 of the Commission's Rules of Practice.
In anticipation of the institution of these proceedings, Clancy has submitted an Offer of Settlement, 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 facts, findings, or conclusions herein, except that he admits the Commission's jurisdiction over him and the subject matter of these proceedings, Clancy consents to the entry of this Order Instituting Proceedings and Opinion and Order Pursuant to Rule 102(e) of the Commission's Rules of Practice ("Order").
The Commission finds that:2
Clancy, age 57, is a certified public accountant licensed in Arizona and Kentucky. In audit year 1996, Clacy practiced as a sole practitioner. In audit year 1997, he was a member of Clancy & Co., P.L.L.C., an accounting firm in Phoenix.3 Clancy audited the financial statements included in the Form 10-K annual reports filed by C.E.C. Industries Corporation ("CEC") for the fiscal years ended March 31, 1996 and March 31, 1997.4
CEC is a Nevada corporation headquartered in Henderson, Nevada. CEC has no core business, no sources of significant recurring revenue, and an inadequate system of internal accounting controls. CEC had only two officers during the relevant period, neither of whom (including its chief financial officer) is a CPA or otherwise has any significant accounting experience. Throughout the relevant period, approximately half of CEC's outstanding stock was owned by other companies controlled by these two officers of CEC.
CEC's common stock is registered with the Commission pursuant to sections 12(b) and 12(g) of the Securities Exchange Act of 1934 [15 U.S.C. §78l(b) and (g)], and traded on the NASDAQ Small Cap market from February 12, 1987 until August 17, 1995, when it was delisted for failing to meet NASDAQ's minimum bid price criteria. CEC's stock has since traded on the OTC bulletin board.5
C. CEC's False and Misleading Financial Statements
CEC's annual reports on Form 10-K for the fiscal years ended March 31, 1996 and March 31, 1997 included financial statements that did not conform with generally accepted accounting principles ("GAAP"). Specifically, the financial statements materially overstated the value of CEC's principal assets and materially overstated substantially all of CEC's revenue.
1. CEC's Overstated Assets
In or about March 1996, CEC acquired certain assets from O.T.S. Holdings, Inc. ("OTS") in exchange for giving OTS a controlling interest in CEC's stock. As part of the transaction, the two principal officers of OTS became directors of CEC as well as CEC's sole officers. Among the assets CEC exchanged with OTS were a collection of paintings by an artist named Sky Jones and a quitclaim deed for a parcel of land in Tennessee.6
In each of CEC's periodic reports filed with the Commission since the exchange with OTS, CEC's balance sheet has materially overstated these two assets. Together, these two assets represented approximately 23 percent of the $11.1 million in total assets reported in CEC's Form 10-K for the fiscal year ended March 31, 1996, and approximately 33 percent of the $7.7 million in total assets reported in CEC's Form 10-K for the fiscal year ended March 31, 1997. Specifically, CEC has reported a value of $1.7 million for its collection of Sky Jones paintings, and a value of $800,000 for its parcel of Tennessee land, which, according to CEC's public filings and statements, contains valuable coal and timber reserves. The paintings and the land had significantly less value during the relevant period.
In or about December 1996, CEC entered into an exchange transaction through which it acquired shares of contractually restricted stock in a company called Synfuel Technologies, Inc. in exchange for a vacant parcel of land CEC owned in Las Vegas. In CEC's periodic reports filed with the Commission since acquiring this stock, CEC has mischaracterized the stock as "free trading shares," "trading securities," and "marketable securities," and its balance sheet has materially overstated this asset. Specifically, CEC reported this stock as a marketable security with a value of $2.7 million as of December 31, 1996, $2.9 million as of March 31, 1997, $1.25 million as of June 30, 1997, $213,625 as of September 30, 1997, and $36,900 as of December 31, 1997. The Synfuel stock had significantly less value during the relevant period.
2. CEC's Overstated Revenues
For its fiscal year ended March 31, 1996, CEC reported total revenues of $1.2 million, substantially all of which it recognized from an asset exchange transaction with a related party. In the transaction, CEC transferred a parcel of vacant land in Utah to the related party in exchange for a promissory note collateralized by CEC preferred stock that was owned by the related party. CEC received no cash down payment and had no reasonable basis to believe the related party was able to pay for the land. Recognition of revenue under such circumstances was not in conformity with GAAP, and thus substantially all of CEC's reported revenue for its fiscal year ended March 31, 1996 was overstated.
For its fiscal year ended March 31, 1997, CEC reported total revenues of $5.9 million, substantially all of which it recognized from two transactions. First, CEC recognized $5 million in revenue from the exchange transaction (described above) through which it acquired restricted stock in Synfuel Technologies, Inc. in exchange for a vacant parcel of land in Las Vegas. Because CEC assigned an overstated value to the Synfuel stock it acquired, and because this transaction was not part of CEC's ongoing major or central operations, recognition of revenue from this transaction was not in conformity with GAAP. Substantially all of CEC's remaining revenue for its 1997 fiscal year was recognized on a transaction CEC misleadingly described as a "sale" of land in Nevada. CEC was in default on its $935,000 mortgage debt in connection with the property, and the lender accepted, among other things, a "deed in lieu of foreclosure" on the property. Recognition of revenue under such circumstances was not in conformity with GAAP, and thus substantially all of CEC's reported revenue for its fiscal year ended March 31, 1997 was materially overstated.
D. Respondent's Conduct
Clancy audited the financial statements included in CEC's annual reports on Form 10-K for the fiscal years ended March 31, 1996 and March 31, 1997. He signed audit reports containing unqualified opinions for both years certifying that the audits were conducted in accordance with generally accepted auditing standards ("GAAS") and that, in his opinion, CEC's financial statements fairly presented CEC's financial position and results of operations in conformity with GAAP. However, Clancy's audits were not conducted in accordance with GAAS and, as a result, Clancy failed to detect that CEC's financial statements were not fairly presented in conformity with GAAP.
In auditing CEC's financial statements, Clancy failed to exercise due professional care and apply the degree of professional skepticism required by GAAS. (See AU §§ 230 and 316A.) CEC was a public company controlled by its two sole officers, with no core business, no significant sources of recurring revenue, and no personnel with any significant accounting experience. Moreover, most of CEC's principal assets were inherently difficult to value, having been acquired in non-cash transactions in exchange for either CEC stock or other assets (typically vacant land) that CEC had previously acquired with stock. Despite the enhanced audit risks created by these circumstances, Clancy's audit programs reveal insufficient consideration of these risks and inadequate audit planning designed to address them.
Clancy also departed from GAAS by failing to obtain sufficient competent evidential matter to support his opinion that CEC's financial statements were presented in conformity with GAAP, particularly given the significance of the relevant assets and transactions to the overall financial position of the company. (See AU §§150 and 326.) Each of the three overstated assets in question was individually material to CEC's balance sheet at all relevant times, and collectively they represented 71 percent of CEC's total reported assets as of March 31, 1997. Moreover, the overstated revenues in question accounted for substantially all of CEC's total reported revenues for the two fiscal years at issue. Nevertheless, Clancy essentially relied on the uncorroborated representations of CEC's two sole officers in satisfying himself that these assets and transactions were accounted for in conformity with GAAP. Although Clancy also purports to have relied upon specialists in determining the value of the assets in question, his reliance failed to comply with GAAS because he gave insufficient consideration to the experience and qualifications of the specialists and because he did not adequately understand the methods and assumptions used by the specialists. (See SAS Nos. 11 and 73; AU §336.12)
For example, with respect to CEC's collection of Sky Jones artwork, Clancy relied on purported appraisals provided to him by CEC's officers to determine the appropriateness of CEC's carryover basis in the asset transferred from OTS. Those appraisals, however, were prepared by the artist himself using a pseudonym. Because Clancy did not sufficiently inquire about the experience and qualifications of the appraiser, and did not attempt to understand the appraiser's methods and assumptions, his audit failed to detect that the appraisals were inappropriate for determining value in CEC's financial statement.
With respect to CEC's Tennessee land with coal and timber reserves, Clancy likewise relied on dubious third-party appraisals provided to him by CEC's officers to determine the appropriateness of CEC's carryover basis in the asset transferred from OTS. Because Clancy did not sufficiently inquire about the experience and qualifications of these appaisers, and did not attempt to understand their methods and assumptions, his audit failed to detect that the appraisals were inappropriate for determining value in CEC's financial statement.
With respect to CEC's investment in Synfuel Technologies, which alone accounted for almost 40 percent of the total assets CEC reported as of March 31, 1997, Clancy attempted to verify the realizable value of the asset by calling a market maker to determine his asking price for Synfuel stock and by consulting the prices reflected for Synfuel in the "pink sheets." Clancy's exclusive reliance on these sources was inadequate because, among other things, CEC was contractually restricted from selling 90% of its Synfuel shares for a period of two years, and in any event there was virtually no liquidity in the market for Synfuel stock. (Typical market volume for Synfuel was less than 500 shares trading per month, whereas CEC's investment was 139,824 shares.) Moreover, CEC's files contained recent Synfuel financial statements disclosing that Synfuel was an insolvent development-stage company with no current assets, operations, or income, that Synfuel's auditors had included a going-concern qualification in their report, and that Synfuel's management believed market trading prices for its stock "would not be representative of the fair value of larger blocks of restricted shares."
Clancy's audit failures also allowed CEC to report substantial increasing revenues throughout the relevant period from transactions described above. As independent auditor, Clancy should have detected that CEC's recognition of revenue from these transactions did not conform with GAAP.
Based on the foregoing, the Commission finds that Respondent William L. Clancy engaged in improper professional conduct within the meaning of Rule 102(e)(1)(ii) of the Commission's Rules of Practice.
Accordingly, IT IS HEREBY ORDERED, effective immediately, that:
A. Respondent William L. Clancy is denied the privilege of appearing or practicing before the Commission as an accountant.
B. After three (3) years from the date of this order, Respondent may request that the Commission consider his reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing or practicing before the Commission as:
1. a preparer or reviewer, or a person responsible for the preparation or review, of any public company's financial statements that are filed with the Commission. Such an application must satisfy the Commission that Respondent's work in his practice before the Commission will be reviewed either by the independent audit committee of the public company for which he works or in some other acceptable manner, as long as he practices before the Commission in this capacity; and/or
2. an independent accountant. Such an application must satisfy the Commission that: (a) Respondent, or the firm with which he is associated, is a member of the SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms ("SEC Practice Section"); (b) Respondent, 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) As long as Respondent appears or practices before the Commission as an independent accountant he will remain either a member of the SEC Practice Section or associated with a member firm of the SEC Practice Section, and will comply with all applicable SEC Practice Section requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education.
C. The Commission's review of an application by Respondent to resume appearing or practicing before the Commission 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.
Jonathan B. Katz
1 Rule 102(e)(1) of the Commission's Rules of Practice, 17 C.F.R. §201.102(e), provides in pertinent part:
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 a hearing in the matter . . . to have engaged in . . . improper professional conduct.
2 The findings herein are not binding on anyone other than Clancy.
3 No other professionals in the firm were involved in the audits in question.
4 CEC has not filed a Form 10-K annual report for the fiscal year ended March 31, 1998 or the fiscal year ended March 31, 1999.
5 On September 28, 1999, the Commission filed a securities fraud action in the United States District Court for the District of Columbia against CEC and its two officers. The Commission's complaint charged all defendants with fraud violations under Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act, and Exchange Act Rule 10b-5. It further charged CEC with violating the reporting and bookkeeping provisions of Exchange Act Section 13 and the rules thereunder, and CEC's two officers with falsifying books and records and failing to implement internal accounting controls in violation of Exchange Act Section 13(b)(5) and Exchange Act Rule 13b2-1. The Commission is seeking permanent injunctions against all defendants, a restatement of past financial statements and the prompt filing of current information by C.E.C., civil penalties against CEC's two officers, and an order prohibiting the officers from serving as directors or officers of any public companies.
6 OTS was audited by an auditor unrelated to Clancy.