UNITED STATES OF AMERICA
SECURITIES EXCHANGE ACT OF 1934
ACCOUNTING AND AUDIT ENFORCEMENT
The Securities and Exchange Commission (Commission) issued its Order Instituting Proceedings (OIP) on April 14, 1999. A hearing is scheduled for March 19-23, 2001, in Salt Lake City, Utah. On March 9, 2001, Wallace T. Boyack, Esq., renewed an earlier motion seeking leave to withdraw as counsel for Respondents. In support, counsel stated that Respondent Kevin E. Orton (Orton) had directed him to cease any and all further representation in this matter and that Orton had no objection to Mr. Boyack's withdrawal as counsel.
The renewed motion to withdraw was accompanied by a statement from Respondent Orton. Orton stated that Respondents would not appear at the hearing scheduled to commence on March 19, 2001, either in person or through counsel. He further advised that they would not request the issuance of any subpoenas, present any expert witness report or testimony, or submit any witness or exhibit lists. On March 12, 2001, Orton telephoned this Office to state that Respondents would not participate in the telephonic prehearing conference scheduled for March 14, 2001.
On March 12, 2001, I granted Mr. Boyack's renewed motion to withdraw as counsel for Respondents, pursuant to Rule 102(d)(4) of the Commission's Rules of Practice.
Based on Orton's statements of March 9 and March 12, 2001, the Division of Enforcement (Division) filed a motion for summary disposition on March 13, 2001. In light of all the circumstances, however, I will treat the Division's motion as a request to hold Respondents in default.1 Given Respondents' failure to appear at the March 14, 2001, prehearing conference, and their determination not to participate further in these proceedings, I now find that Respondents are in default under Rule 155(a)(1) of the Commission's Rules of Practice.
Based on the OIP and the record of this proceeding, I find that:
PanWorld Minerals International, Inc. (PanWorld) is a Nevada corporation that was formed in Utah in June 1984 under the name Ridgtop Resources, Inc.
On or about July 10, 1995, PanWorld filed with the Commission an annual report on Form 10-KSB, which contained its financial statements for the year ending December 31, 1994. The certified public accounting firm of Orton & Company (ORCO) issued an unqualified audit report on PanWorld's financial statements stating, among other things, that its audit was conducted in accordance with generally accepted auditing standards (GAAS) and that the consolidated balance sheet presented fairly the financial position of PanWorld in conformity with generally accepted accounting principles (GAAP).
Respondent Orton, a resident of Midvale, Utah, is a certified public accountant (CPA) and was engaged in public accounting at all relevant times. Orton was the engagement partner on the audit of the financial statements of PanWorld for the year ended December 31, 1994.
Respondent ORCO, an accounting firm, is a Utah professional corporation formed in 1988. ORCO's registration as a professional corporation lapsed on June 21, 1993, and was not reinstated until June 4, 1996. Orton is the sole director, shareholder, officer, and employee of ORCO. The audit report on PanWorld's 1994 financial statements, dated May 26, 1995, was printed on ORCO letterhead and signed by Orton. The letterhead contained several misrepresentations concerning the professional affiliations of ORCO.
PanWorld was headquartered in Salt Lake City, Utah. PanWorld was a reporting company pursuant to Section 15(d) of the Securities Exchange Act of 1934 (Exchange Act) from 1989 through October 8, 1994. On October 9, 1994, PanWorld became a Section 12(g) reporting company. PanWorld's primary business activity was acquiring mining properties, mainly in the western United States and South America. On June 2, 1997, the Commission filed a civil injunctive action against PanWorld and several of its officers and employees, charging violations of the antifraud, registration, and periodic reporting provisions of the federal securities laws. That proceeding has been stayed pending the outcome of criminal charges against certain of the defendants named in the injunctive action.
This Order finds that Respondents Orton and ORCO engaged in improper professional conduct in connection with the audit of PanWorld's financial statements for the year ended December 31, 1994. PanWorld's financial statements for that year were not prepared in conformity with GAAP. Among other deficiencies, the consolidated balance sheet reported mining assets at substantially inflated book values derived from arbitrary par values assigned to unregistered and unmarketable preferred stock issued by PanWorld in exchange for those assets. Nevertheless, Respondents stated in their audit report that PanWorld had prepared its financial statements in conformity with GAAP. Respondents also recklessly disregarded applicable professional standards under GAAS in their conduct of the audit in that they failed to: obtain sufficient, competent evidential matter; exercise due professional care and appropriate professional skepticism; and adequately plan the audit.
Respondents Failed To Ensure That PanWorld's Financial Statements Were Prepared In Conformity With GAAP.
As of December 31, 1994, mining properties carried at $10,367,924 represented over 99% of total assets on PanWorld's consolidated balance sheet. PanWorld valued at $6.2 million, the same valuation given in the prior year, certain placer mining assets and alleged proprietary technology which PanWorld allegedly acquired for one million shares of PanWorld convertible preferred stock with a par value of $6 per share and the assumption of certain liabilities. PanWorld claimed that its valuation of the assets was supported by an appraisal at $10.5 million, although the appraisal was performed by a PanWorld consultant who was not independent and was not a qualified appraiser.
PanWorld claimed a 70% interest in an iron ore property in southern Peru and carried the interest on its balance sheet at $3,286,081. PanWorld valued the project based upon the purchase price of $40,000 cash and 321,000 shares of convertible preferred stock that the company valued at $10 per share. PanWorld acquired its interest in the iron ore property through a series of related party transactions that inflated the price from its initial cost of $21,000.
PanWorld claimed a 30% net revenue interest in three Bolivian gold mines that PanWorld carried at $900,000 in 1994. For the 30% interest, PanWorld issued thirty million shares of Regulation S stock to an affiliate of the seller. PanWorld had no credible appraisal or geological study to support any valuation at all for the gold mining interest.
Valuation of assets based solely on the par value of preferred stock given in exchange is not acceptable under GAAP. PanWorld never had a reasonable basis for establishing a fair value for its unregistered preferred stock in that no trading market existed for those securities. Moreover, PanWorld failed to deliver the full amount of cash and stock required under the contracts. Finally, PanWorld never obtained sufficient geological data concerning the mineral reserves on the properties, economic data concerning the technology and equipment, or an appraisal by an independent qualified expert to support the assigned carrying values.
Respondents Failed To Comply With GAAS.
Orton and ORCO failed to gather competent evidential matter sufficient to provide reasonable support for ORCO's audit report that contained an unqualified opinion that PanWorld's financial statements were presented in conformity with GAAP. ORCO's audit work papers show that Orton inappropriately relied on PanWorld's management representations and the 1993 audit report issued by a predecessor auditor to conclude that the placer mining assets carried over from the prior year were accounted for properly. Although requested by Orton, PanWorld was unable to produce a finalized purchase agreement at the time of the audit, and Orton took no steps to determine whether the purchase agreement for the placer mining assets had ever been consummated. Orton took no documented steps to obtain an updated appraisal, other corroborating evidence, or independent verification of the company's initial valuation or carrying value at December 31, 1994, of the placer assets. Orton either did no research, or failed to document what research he might have done to determine whether, under GAAP, nonmonetary assets could be booked at the par value of preferred stock with limited marketability issued for such assets. In support of the accounting treatment, Orton accepted at face value a memorandum written more than five years prior to ORCO's audit by former PanWorld auditors who in 1991 withdrew their audit report on PanWorld's 1989 financial statements. Orton failed to acquire an understanding of the unusual and unorthodox valuation method employed by a PanWorld consultant in preparing an appraisal or report in which, among other things, equipment was valued based upon its weight and complexity, and he failed to obtain sufficient information regarding the professional qualifications or independence of the consultant who prepared the report. Finally, Orton failed to reconcile the alleged appraised value of the placer mining assets with what PanWorld recorded on the books. The foregoing references to the documentation used by PanWorld in the original capitalization are relevant to this analysis because the carrying value of the placer mining assets did not change from 1993 to 1994.
The material additions to PanWorld's mining properties in 1994 consisted of the iron ore project and the net revenue interest in the Bolivian gold mines valued at more than $4.1 million. ORCO's work papers contain no documentation of audit procedures that should have been planned and applied to a geological report used by PanWorld to support the value of the iron ore deposit. Orton and ORCO failed to gather any evidential material that could form the basis for a reasoned professional judgment on the reliability of the geological report. As a result, Orton failed to discover that the author of the report had a direct financial interest in the appraised property. Moreover, Orton was aware that PanWorld never acquired sufficient geological data to support booking the Bolivian mining interest at any value. The uncertainties regarding the existence, extraction, and sale of gold ore created an accounting recognition problem such that, under GAAP, the net revenue interest could not be booked as an asset. Orton failed in his professional obligation to gather sufficient, competent evidence addressing the valuation or the likelihood of future economic benefit from either the iron ore project or the Bolivian properties.
Orton also failed to maintain appropriate professional skepticism and exercise due professional care, as required by GAAS. Orton failed to consider the auditing implications of severe management and accounting problems at PanWorld, including the resignation or discharge of four predecessor auditors between 1990 and 1995. There is no documentation in ORCO's audit work papers that Orton considered the internal control weaknesses at PanWorld resulting from the small employee group, lack of an accounting department, and total control of PanWorld's financial matters by two corporate officers.
Orton failed properly to plan the audit of PanWorld's 1994 financial statements. Orton used a set of generic audit work programs to develop his audit plan. There is no documentation on ORCO's audit work papers to suggest that Orton tailored his audit program to address areas of greatest audit exposure. Most pages of Orton's audit program are blank, and those pages where Orton's initials appear are not dated. ORCO's audit work papers contain no notations of any audit work performed and no cross-references to supporting schedules or work papers.
The audit report on PanWorld's 1994 financial statements, dated May 26, 1995, was printed on ORCO's letterhead, which contained a legend stating that ORCO was a member of the Utah Association of Certified Public Accountants and a member of the SEC Practice Section of the American Institute of Certified Public Accountants' Division for CPA Firms. Both representations were false on that date.
Respondents Engaged In Improper Professional Conduct.
Orton and ORCO engaged in improper professional conduct in connection with their examination of PanWorld's 1994 financial statements in that they intentionally, knowingly, or recklessly violated applicable professional standards.
The improper professional conduct of Orton and ORCO included: (1) falsely representing in an audit report that the examination had been performed in accordance with GAAS and that PanWorld's financial statements were prepared in conformity with GAAP; (2) failing to exercise due professional care and maintain appropriate professional skepticism in the conduct of the examination of PanWorld's financial statements; (3) failing to gather sufficient, competent evidential matter in the course of the examination sufficient to afford a reasonable basis for the conclusions expressed in the audit report; and (4) failing to plan the audit in a manner that would result in an effective audit program, which would reflect the auditor's reasoned inquiries about areas of special concern and heightened audit risk.
Pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice, Kevin E. Orton and Orton & Company are denied the privilege of appearing or practicing before the Commission.
1 On March 12, 2001, the Commission issued an Order summarily suspending Orton from appearing and practicing before it. The Commission's Order was issued under Rule 102(e)(2) of the Commission's Rules of Practice. It was based on a judgment of conviction entered against Orton on March 7, 2001, in an unrelated matter. The Commission's Order was limited to Orton, and did not address Orton & Company. The Commission's Order did not dismiss this proceeding.