UNITED STATES OF AMERICA
In the Matter of
JEFFREY BACSIK, CPA,
|ORDER INSTITUTING PUBLIC ADMINSTRATIVE PROCEEDINGS PURSUANT TO RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE AND FINDINGS AND ORDER OF THE COMMISSION|
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be and hereby are instituted against Jeffrey Bacsik ("Respondent") pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice1 to determine whether Bacsik engaged in improper professional conduct.
In anticipation of the institution of this administrative proceeding the Respondent has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purposes of this proceeding and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, without any hearing, and without admitting or denying the Commission's findings contained herein other than those contained in part III of the Order under the headings "the respondent" and "related entity," and that the Commission has jurisdiction over him and over the subject matter of this proceeding, Respondent consents to the entry of this Order and the findings and imposition of remedial sanctions set forth below.
On the basis of this Order and the Respondent's Offer of Settlement, the Commission makes the following findings:
Jeffrey Bacsik is a certified public accountant licensed in Connecticut, New Jersey and New York. At all relevant times he was a partner in the accounting firm of Deloitte & Touche ("Deloitte"). Bacsik served as engagement partner for the audits of the year-end financial statements of Fine Host Corporation from at least 1993 through Fine Host's fiscal year ended December 25, 1996. He was also the engagement partner for the reviews of Fine Host's quarterly financial statements for the relevant periods in fiscal 1996 and for the first quarter of fiscal 1997.
Fine Host Corporation is a Connecticut-based company that, at all times relevant to this Order, provided food and beverage concession, catering and other services to approximately 400 facilities in 38 states. Fine Host conducted an initial public offering in June 1996, and a secondary offering in February 1997. Its stock was registered with the Commission under Section 12(g) of the Exchange Act and listed for trading on the Nasdaq National Market System. On January 7, 1999, subsequent to the extensive restatement of its financial statements, Fine Host entered a proceeding under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to its plan of reorganization, Fine Host has now become a private entity.
Fine Host Corporation engaged in an extensive financial fraud that, when detected, resulted in the collapse of its stock price and, eventually, the end of its existence as a public company. The scheme predated Fine Host's June 1996 initial public offering by several years and continued through the third quarter of the fiscal year ended December 31, 1997. It involved, as its primary mechanism, the improper capitalization of millions of dollars in Company expenses as assets. Fine Host also manipulated acquisition reserve accounts, income from vendor rebates, and other items for the purpose of managing reported earnings.
Based on an internal investigation, Fine Host issued a restatement of its financial statements in February 1998, reflecting that Fine Host had overstated its pretax income for fiscal years 1992 through 1996 by over $28 million, and for the first three quarters of 1997 by $21 million. For fiscal years 1994, 1995 and 1996, Fine Host had overstated pretax income by 149%, 213%, and 197%, respectively.
Bacsik, as the engagement partner on the Deloitte audit team, failed to ensure that the audit team conducted appropriate audit procedures, in many instances improperly relying on representations of Company management as the principal source of audit evidence. This failure to exercise due professional care; to ensure that the audit team obtained sufficient competent evidential matter; and to maintain an attitude of professional skepticism constituted improper professional conduct for purposes of Commission Rule of Practice 102(e).
Fraudulent Accounting Practices in the Period Leading Up To the Initial Public Offering
Fine Host's improper accounting for "contract rights"
Fine Host's operations were based on securing contracts to provide food and beverage services to sports arenas, schools, convention centers, and other facilities. Beginning when Fine Host was a private company, its accounting practice was to aggregate certain costs associated with the pursuit of those contracts in an "acquisition costs" account. When a contract was signed, the costs attributed to it were then transferred to the "contract rights" account and were treated as capitalized costs to be amortized over the term of the contract.2
This practice was permissible under generally accepted accounting principles ("GAAP") only to the extent these costs were directly related to the acquisition of assets with a future economic benefit to Fine Host. In practice, however, Fine Host routinely and improperly allocated a pool of general and administrative ("G&A") expenses to the contract rights account, without any documentary support for this practice, rather than properly recognizing these overhead costs as period expenses. Each quarter, Fine Host assigned a certain (arbitrarily determined) percentage of total costs to each facility. Fine Host then allocated costs to specific facilities by multiplying the total costs for the quarter by the facility's assigned percentage.
Audit failures during the pre-IPO period.
Before (as well as after) Fine Host's June 1996 IPO, Bacsik and other members of the audit team did little to evaluate the appropriateness of Fine Host's accounting for "contract rights" or to ensure that Fine Host's capitalized costs conformed to GAAP. In connection with the audit of Fine Host's 1995 financial statements (the most current annual statements included in the registration statement for its 1996 IPO), the Deloitte audit team, under the supervision of Bacsik and others, sampled only nine items - totaling $9,332 - to test total contract acquisition costs of $4.6 million. These included airfare, lodging, food, flowers, and color illustrations for a proposal, items that, on their face, are unlikely subjects for capitalization.
In addition, a schedule prepared by Fine Host's management revealed that Fine Host was allocating costs to particular facilities based on percentages of total costs capitalized, with the same percentages assigned to multiple locations. This meant that identical amounts were capitalized at multiple locations, a clear indication that costs were being assigned on an arbitrary basis, a practice not in conformity with GAAP. Nevertheless, Bacsik and the audit team did not question this practice.
Fine Host's improper treatment of contract acquisition costs in the period preceding its IPO was material. In its restatement, Fine Host wrote-off $2,458,000 of such costs as improperly capitalized in 1994, representing approximately 75% of pretax income for the year. For 1995, Fine Host wrote-off $4,284,000 in contract acquisition costs, approximately 113% of pretax income for the year. Bacsik signed Deloitte's unqualified audit report for the restatement in February 1998. He also signed the Deloitte audit reports on the 1994 and 1995 financial statements when they were originally issued, before Fine Host was a reporting company, and consented to the reissuance of those reports in connection with the 1996 IPO.
Fine Host's Improper Accounting for Acquisition Reserves
Fine Host frequently acquired other companies in the food services industry. These acquisitions provided another vehicle to manipulate Fine Host's earnings. For each acquisition, Fine Host would set up goodwill and an acquisition reserve. These reserves were then used as a "cookie jar" to offset losses on a discretionary basis, sometimes two or three years after the acquisition.
In many instances, Fine Host did not discontinue any activity in connection with these acquisitions, or incur costs related to these acquisitions, such as those for terminated employees, which were the basis for establishing such reserves under GAAP. Typically, little (if any) documentation supported the amount taken as a reserve. Indeed, as Fine Host's report of internal investigation later concluded: "[o]ften the only available documentation consisted of the journal entry used."
Bacsik failed to ensure that the audit team performed any significant analysis of these acquisition reserve accounts, thus failing to detect that they were being used as a means of fraudulently manipulating Fine Host's results of operations.
Fine Host's Improper Accounting for Vendor Rebates
Fine Host received rebates and signing bonuses from various vendors throughout the relevant period. Its practice was to estimate, at the beginning of each year, the amount of rebates and signing bonuses it expected to receive throughout the year, then recognize income monthly on a pro rata basis. As was later acknowledged by both Fine Host and Deloitte, Fine Host did not substantiate that it would realize the rebate receivable balance that it had recorded. Separately, Fine Host also immediately and improperly recorded as income the entire amount of signing bonuses received from vendors (or expected to be received), even when such signing bonuses related to multiple-year contracts.
The effect of this practice on Fine Host's results of operations for 1994 and 1995 was to increase income by $330,000 and $554,000, respectively. As alleged below, moreover, the effect ballooned in later periods, causing Fine Host to eventually write off $5.5 million of rebates receivable, $3.9 million of which was in the first three quarters of 1997.
Bacsik failed to ensure that his audit team performed any significant audit procedures during the pre-IPO period to verify that Fine Host's rebate receivable balance was collectible. Instead, Bacsik and the audit team relied on management representations concerning the accuracy of Fine Host's financial statements.
The Fine Host IPO
The registration statement for the Fine Host IPO was filed on March 29, 1996. In its Form S-1, Fine Host reported results of operations for the fiscal years 1993-95. Bacsik served as the Deloitte engagement partner during the IPO process.
The staff of the Commission's Division of Corporation Finance reviewed the registration statement and questioned Fine Host's accounting policy for contract rights. In response, Fine Host represented that, for all periods after year-end 1995, it would capitalize only two categories of costs associated with contract acquisitions: direct payments made to clients to acquire the contracts and the direct costs of obtaining licenses and permits to operate its contract locations. Fine Host specifically represented that it would no longer capitalize commissions and proposal costs. Finally, Fine Host represented that it had not amended its financial statements for the years covered by the registration statement to conform with this policy "since the impact of this adjustment would not be material for any year presented." In fact, the misstatement of Fine Host's financial results due to improper capitalization of contract rights was material for each fiscal year 1993 through 1995.
Bacsik was involved in the IPO review process. He reviewed staff comment letters and Fine Host's responses. Bacsik was aware of Fine Host's representation that certain categories of costs it had previously capitalized would be treated as period expenses subsequent to year-end 1995. He was also aware that Fine Host management had represented to the Commission staff that Fine Host did not restate its financial results for the periods covered by the registration statement because the costs it had improperly capitalized as contract rights were not material to any period. This representation was inaccurate but Bacsik accepted it. As noted above, however, a material portion of Fine Host's pre-tax income for 1994 and 1995 was attributable to its improper accounting practices.
The Form S-1 went effective on June 19, 1996. Net proceeds to the Company from the offering were approximately $32 million.
The Fiscal Year Ended December 25, 1996
Following the IPO, Fine Host improperly continued to spread G&A expenses among its capitalized "contract rights." The aggregate "contract rights" balance increased every quarter in fiscal year 1996.3 In fiscal year 1996, additions to contract rights totaled $12.2 million, while additions to the fixtures and equipment account approximated $16.5 million.
The items capitalized went well beyond both the two cost categories Fine Host had represented to the Commission staff it would capitalize in the future and the capitalized cost categories it disclosed in its 1996 Form 10-K. In Fine Host's restatement, $5.6 million of capitalized 1996 contract acquisition costs were reversed as improper. This represented approximately 98% of Fine Host's pretax income for that year.
During 1996, Fine Host also became increasingly aggressive in misusing acquisition reserves and rebates to conceal its deepening financial problems. Fine Host improperly lowered its expenses by offsetting $2.65 million in operating expenses against previously recorded acquisition reserves. This inflated Fine Host's pretax income by 41%. Income from rebates was overstated by approximately $800,000 for 1996.
Audit failures in 1996
After the IPO, the failure of Bacsik and other members of the audit team to detect Fine Host's accounting fraud continued through an additional year-end audit. Bacsik knew (from the IPO review process) that Fine Host had a history of capitalizing G&A expenses as "contract rights," and he also knew that Fine Host had, in 1996, added $12.2 million in additional "contract rights" to its balance sheet. Nevertheless, Deloitte auditors, under the supervision of Bacsik and others, did inadequate testing in this area.
Even the limited procedures performed by Bacsik's audit team provided indications of problems that warranted further inquiry. Deloitte auditors, including Bacsik, knew that Fine Host had capitalized employee sales commissions during 1996 and should have known that this practice did not conform to GAAP.
During 1996, Fine Host partially shifted its fraudulent capitalization of period expenses from the contract rights account to the fixtures and equipment accounts. A schedule provided by management to Deloitte disclosed that 1996 additions to the fixtures and equipment accounts approximated $16.5 million. These significant additions should have caused the Deloitte auditors, including Bacsik, to conduct a more detailed examination of this area. They did not, however, request a detailed list of these additions, or supporting documents such as vendor invoices. Bacsik's audit team examined a sample of only eight property additions during the 1996 audit, totaling $213,628 or approximately 1.3% of total property additions
Similarly, Deloitte auditors, under the supervision of Bacsik and others, failed to provide any meaningful review of Fine Host's accounting for acquisition reserves and vendor rebates. That year reserves were established for four acquisitions, totaling more than $4.9 million. Bacsik and the audit team accepted the representations of Company management concerning the appropriateness of these additions, without conducting a detailed analysis of these reserves or obtaining sufficient evidential matter to test the reserves for compliance with GAAP requirements. With respect to vendor rebates, Bacsik and the audit team did not address the issue in any significant way.
On February 7, 1997, Fine Host conducted a secondary offering of 2,689,000 shares of its common stock, with net proceeds to Fine Host of approximately $59 million. The registration materials contained financial information for fiscal years 1994 and 1995 and for the nine-month period ended September 25, 1996, that as noted above, was materially false and misleading. Bacsik served as the Deloitte engagement partner in connection with this registration statement.
By the autumn of 1997, amortization of Fine Host's growing contract rights balance was eating into reported earnings, and Fine Host was experiencing increasing difficulty in meeting analysts' expectations. Alerted by a member of management that certain of the Company's accounting practices were questionable, the independent directors initiated an internal investigation. In February 1998, at the conclusion of this investigation, Fine Host announced that it had overstated its pretax income by $28 million for the fiscal years 1992 through 1996 and by $21 million in the first three quarters of 1997.
In Fine Host's restatement, eighteen categories of material accounting errors were identified, with improperly capitalized contract rights of $21.7 million being the largest. Acquisition reserves totaling $8.4 million were written off because (i) they were costs that should have been expensed as incurred, (ii) the Company lacked documentation linking them to a particular acquisition or (iii) the reserve, when properly decreased, already had been exhausted. In addition, Fine Host wrote off purported rebates receivable in the amount of $5.5 million, because they were supported by little if any documentation. Bacsik, as the engagement partner, signed Deloitte's unqualified audit report on Fine Host's restated financial statements.
On January 7, 1999, Fine Host entered a proceeding under Chapter 11 of the U.S. Bankruptcy Code. Pursuant to its plan of reorganization, Fine Host has now become a private entity.
Bacsik Engaged in Improper Professional Conduct for Purposes of Commission Rule of Practice 102(e)
Bacsik failed to obtain sufficient competent evidential matter
In conducting an audit, an auditor must obtain sufficient competent evidential matter through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. AICPA Codification of Statements on Auditing Standards ("AU") § 326.01.
Based on the foregoing, in connection with Fine Host's 1996 registration statement (which incorporated Fine Host's financial statements for fiscal years 1993 through 1995), Fine Host's 1997 registration statement, and Fine Host's year-end 1996 financial statements, Bacsik failed to ensure that the audit team obtained sufficient competent evidence in support of Fine Host's accounting for: (1) capitalized "contract rights;"(2) capitalized "fixtures and equipment;" (3) vendor rebates; and (4) acquisition reserves.
Bacsik failed to maintain an attitude of professional skepticism
An auditor is required to exercise professional skepticism when performing audit procedures and gathering and analyzing audit evidence. AU § 230.07.
Based on the foregoing, in connection with Fine Host's 1996 registration statement (which incorporated Fine Host's financial statements for fiscal years 1993 through 1995, Fine Host's 1997 registration statement, and Fine Host's year-end 1996 financial statements, Bacsik failed to maintain an attitude of professional skepticism concerning Fine Host's accounting for: (1) capitalized "contract rights;"(2) capitalized "fixtures and equipment;" (3) vendor rebates; and (4) acquisition reserves. Specifically, Bacsik accepted uncorroborated representations of Fine Host's management in lieu of performing appropriate audit procedures, in contravention of AU § 333. "[R]epresentations from management are part of the evidential matter the independent auditor obtains, but they are not a substitute for the application of those auditing procedures necessary to afford a reasonable basis for an opinion regarding the financial statements under audit." AU § 333.02.
Bacsik failed to render accurate audit reports.
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 § 508.04. The auditor can determine that he is able to express an unqualified opinion only if he has conducted his audit in accordance with GAAS. AU § 508.07.
Based on the foregoing, Bacsik failed to render accurate audit reports when he stated in the audit reports for fiscal years 1993 through 1995 that were included in Fine Host's 1996 and 1997 registration statements and in the audit report for fiscal year 1996 that Fine Host's financial statements were in conformity with GAAP and that the audits were performed in accordance with GAAS. In fact, the financial statements were not in conformity with GAAP, and the audits were not performed in accordance with GAAS.
Bacsik failed to exercise due professional care
Auditors must exercise due professional care in performing the audit and preparing the audit report. AU § 230.01.
Based on the foregoing, in connection with Fine Host's 1996 registration statement (which incorporated Fine Host's financial statements for fiscal years 1993 through 1995), Fine Host's 1997 registration statement, and Fine Host's year-end 1996 financial statements, Bacsik failed to exercise due professional care by failing to plan and supervise properly audit procedures necessary to afford a reasonable basis for the audit opinions.
Based upon the foregoing, the Commission finds that, in connection with the audits of the financial statements of Fine Host Corporation, Jeffrey Bacsik engaged in improper professional conduct for purposes of Rule 102(e) of the Commission's Rules of Practice. Specifically, Bacsik was responsible for repeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards.
IT IS HEREBY ORDERED, effective immediately, that:
Jeffrey Bacsik be, and hereby is, denied the privilege of appearing or practicing before the Commission as an accountant. After two (2) years from the date of this Order, Bacsik 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 Bacsik'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. Bacsik, or any firm with which he is or becomes 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. Bacsik, 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 Bacsik 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.
The Commission's review of any request or application by Bacsik to resume appearing or practicing before the Commission may include consideration of, in addition to the matters referenced above, any other matters relating to Bacsik's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
Jonathan G. Katz
|1|| Rule 102(e)(1) 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 have engaged in unethical or improper professional conduct. Improper professional conduct includes repeated instances of unreasonable conduct, each resulting in a violation of applicable professional standards, that indicate a lack of competence to practice before the Commission.
|2||In addition, substantial amounts of these costs were improperly capitalized in the "fixtures and equipment" accounts, particularly in 1996 and 1997.|
|3||Deloitte conducted reviews of Fine Host's quarterly financial statements throughout the relevant period.|
|Home | Previous Page||