UNITED STATES OF AMERICA
In the Matter of
GLENN R. OHLHAUSER, C.A.,
| ORDER INSTITUTING PUBLIC|
MAKING FINDINGS AND IMPOSING
AN ORDER PURSUANT TO RULE
102(e) OF THE COMMISSION'S
RULES OF PRACTICE
The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted against Glenn R. Ohlhauser, C.A. ("Ohlhauser") pursuant to Rules 102(e)(1)(ii) and 102(e)(3)(i)(A) of the Commission's Rules of Practice [17 C.F.R. §§ 201.102(e)(1)(ii) and 201.102(e)(3)(i)(A)].1
In anticipation of the institution of these proceedings, Ohlhauser 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, Ohlhauser consents to the issuance of this Order and to the entry of the findings and imposition of the remedial sanctions set forth below, without admitting or denying the Commission's findings, except that Ohlhauser admits that the Commission has jurisdiction over him and over the subject matter of this proceeding, and admits the Commission's finding in Section IV.B relating to his having been permanently enjoined from future violations of the Federal securities law.
On the basis of this Order and the Respondent's Offer, the Commission finds2 that:
Glenn Ohlhauser, a Chartered Accountant, was the partner in charge of the audit of the December 31, 1997 financial statements of Solucorp Industries Ltd. ("Solucorp"), which were filed in a Form 10-KSB with the Commission. The financial statements overstated revenues by at least 27%. The overstatement resulted from the improper accrual of license fees under an agreement with a Hong-Kong based closely-held company, Smart International Ltd. ("Smart").
In conducting the audit, Ohlhauser failed to exercise due professional care and to obtain sufficient evidential matter to support the company's recognition of the license fees. Indeed, on the basis of information known to him, Ohlhauser had ample reason to know that Solucorp's accrual of the license fees was not in conformity with generally accepted accounting principles ("GAAP"). Nonetheless, Ohlhauser, on behalf of his firm, MacKay & Partners LLP, now MacKay LLP, ("MacKay"), signed and issued an unqualified audit report on Solucorp's December 31, 1997 financial statements.
Glenn R. Ohlhauser, age 49, a Chartered Accountant ("C.A.") licensed in British Columbia, Canada,3 was the MacKay partner in charge of the audit of Solucorp's financial statements for the period ended December 31, 1997. He had been the partner in charge of the audits of Solucorp's financial statements for two years prior to 1997, and continued in that capacity through the audit of Solucorp's December 31, 1998 financial statements. Ohlhauser resigned from MacKay in 2000.
C. Relevant Entity
Solucorp Industries Ltd. is a Yukon Territory corporation headquartered in New York that engages in the treatment and disposal of contaminated soil and in developing, marketing and licensing of products for use in environmental cleanups, including its so-called "Molecular Bonding System" ("MBS"). Solucorp's securities are registered with the Commission pursuant to Section 12(g) of the Securities Exchange Act of 1934 ("Exchange Act"). During the relevant time period, Solucorp undertook to prepare its financial statements in conformity with Canadian GAAP.
In December 1997, Ohlhauser was asked by Solucorp to reconcile Solucorp's financial statements for the quarter ended September 30, 1997 from Canadian GAAP to U.S. GAAP for inclusion in a registration statement Solucorp planned to file with the Commission. On the basis of a limited review of the financial statements, Ohlhauser concluded that they were materially misstated because the company had improperly accrued $500,000 in license fees purportedly receivable from Smart, which comprised 40% of Solucorp's reported revenues for the quarter. The only document in existence at the time between Solucorp and Smart pertaining to Smart's use of MBS in China was a non-binding "agreement in principle" dated June 4, 1997. Ohlhauser regarded this agreement as too vague and contingent to support revenue recognition.
On December 18 and 19, 1997, Ohlhauser conveyed his concerns to Victor Herman, the chief financial officer of Solucorp's chief operating subsidiary, and recommended that Solucorp restate its September 30, 1997 financial statements, which had already been filed with a Canadian regulatory authority in November 1997. Herman responded that no restatement was necessary as revenue recognition of the license fees was proper. Herman told Ohlhauser that Solucorp and Smart had spent the last several months of 1997 negotiating the terms of the final agreement, and that Solucorp representatives had traveled to China in the fall for that purpose. Herman further stated that Smart had already paid $200,000 and would be paying $300,000 shortly.4 He further explained that the final agreement, which had yet to be memorialized, would address Ohlhauser's concerns. Ohlhauser continued to regard the financial statements as materially misstated.
Solucorp filed its Form 10-KSB registration statement with the Commission on December 22, 1997. The company was required to attach copies of all material contracts (see 17 C.F.R. § 228.601(b)(10)). With respect to its agreement with Smart, the company attached only a copy of the non-binding June 4, 1997 agreement in principle. No mention was made of the parties finalizing the terms of a license agreement, with the exception of a footnote to the June 30, 1997 financial statements included in the Form 10-KSB, which described the terms of the June 4 agreement in principle and stated simply that the parties had finalized the agreement after June 30, 1997.
In late 1997, Solucorp changed its fiscal year from June 30 to December 31. In its financial statements for the six-month transition period ended December 31, 1997, Solucorp recognized $1,090,000 in Smart license fees, which comprised approximately 50% of its total revenues. MacKay audited the financial statements in early 1998.
In late February 1998, during the audit, Ohlhauser requested to see a copy of the final license agreement negotiated by the parties. Solucorp provided Ohlhauser with a copy of the license agreement with Smart that superseded the June 4, 1997 agreement in principle.
The final agreement included a provision that enabled Smart, at its own determination in limited circumstances, to convert amounts owed to Solucorp to "pre-paid inventory" of calcium sulfide. Smart produced calcium sulfide for use in the MBS process pursuant to an agreement entered into in March 1997. In effect, Smart could substitute future production of calcium sulfide for monies owed to Solucorp. However, Smart was under no legal obligation to produce calcium sulfide.
This superseding agreement had a commencement date of June 1, 1997 and was "dated as of" September 15, 1997. The signers of the agreement, Solucorp's president, Peter Mantia, and Smart's principal, both cited September 15, 1997 as their signature date. In fact, the agreement's terms had been finalized and executed on or about December 30, 1997.
Ohlhauser observed in a March 10, 1998 memo to Herman that the agreement appeared to have been backdated, as no mention of the agreement was made in the Form 10-KSB registration statement filed with the Commission on December 22, 1997. Ohlhauser further observed that he did not "know what [the] SEC may say if these new `facts' aren't consistent with items previously filed." Notwithstanding that Herman had informed Ohlhauser in December 1997 that the parties were then engaged in negotiations that had been going on for several months, he now contended to Ohlhauser that Mantia had finalized the contract during a visit to China on September 15, 1997, and that Herman would address the issue of backdating with the Commission if it arose.
While grappling with the accounting issues arising from the backdating of the license agreement, Ohlhauser also questioned the parties' noncompliance with the terms of the agreement "dated as of" September 15, 1997. Of particular concern to him was Smart's failure to pay the license fee in accordance with the agreement's terms, and the fee's questionable collectibility. As of December 31, 1997, Smart had paid only $500,000 in license fees. This consisted of a $150,000 payment in cash, and an offset of $350,000 in overdue license fees against an equivalent amount Solucorp would owe Smart for Smart's production of calcium sulfide.
In a memo to Herman dated February 27, 1998, Ohlhauser observed that "GAAP (both Can[adian] and US) states that `revenues from the use of others of enterprise resources should be recognized when reasonable assurance exists regarding measurement and collectibility.'" Commenting that at that time he lacked the information necessary to assess the appropriateness of revenue recognition, Ohlhauser requested information relating to, among other things, Smart's ability to pay. He commented further that Solucorp had a "potential problem if [Smart] intend[s] to pay in product," questioning where the product would be stored and how Solucorp would get to the inventory in the event of default.
In March 1998, Smart confirmed to Ohlhauser the $150,000 cash payment and $350,000 offset, and amounts earned and unbilled as of March 1998. With this confirmation in hand, Ohlhauser continued to press Herman over the next month for evidence of the fees' collectibility. Of particular concern to Ohlhauser was the fact that Smart had made no further payments, even though an additional $1 million in license fees had been due as of March 31, 1998 under the terms of the final agreement.5 Moreover, throughout this period, Solucorp continued to advance funds to Smart toward the purchase of calcium sulfide even though Smart was delinquent in paying its license fees.
In a memo to Herman dated April 3, 1998, Ohlhauser stated that he was "still waiting for additional evidence regarding payment or other evidence to show amount is collectable." In another memo to Herman dated April 9, 1998, Ohlhauser stated that he had not resolved the issue of Solucorp's license fee accrual. Ohlhauser further stated that he did not "see evidence that [the] contract terms are being complied with." Ohlhauser cautioned that, "[i]f there was an inference that [Solucorp's] collection might be dependent on Smart developing future business and sales from the agreement, then I think [the] SEC would only allow revenues to be recorded as received. . . ."
Ohlhauser repeatedly requested that Herman obtain financial statements from Smart or other comparable data that would address Smart's financial wherewithal to pay the license fees. Herman refused to obtain this information on the grounds that it would offend the Chinese company.6 Herman insisted that the fees were collectible, but that Solucorp refused to pressure Smart for payment because Smart had agreed in 1997 to undertake the manufacture of calcium sulfide when Solucorp encountered difficulty locating another supplier.
In his final memorandum to the file, dated April 14, 1998, summarizing the key audit issues, Ohlhauser wrote that Solucorp's accrual of license fees was reasonable provided that collection could be properly determined. Observing that he had "no information on ability of Smart to pay," Ohlhauser added that the "audit evidence on collectibility" such as it was, consisted of Smart's confirmation and the fact that Smart was a supplier of calcium sulfide. Ohlhauser further acknowledged in the memo his concern that if license fees "are not paid there is no recourse for collection."
Ohlhauser issued an unqualified audit report on Solucorp's financial statements for the six-month transition period ended December 31, 1997. These financial statements were included in the Form 10-KSB Solucorp filed with the Commission on April 15, 1998.
E. Legal Analysis
1. Solucorp Improperly Recognized the Smart License Fees
Section 4-01 of Regulation S-X [17 C.F.R. § 240.4-01(a)(1)] requires that financial statements included in a transition report filed with the Commission must be prepared in accordance with GAAP. Financial statements prepared in accordance with a comprehensive set of GAAP other than U.S. GAAP must be reconciled to U.S. GAAP in the footnotes to the financial statements. Solucorp undertook to prepare its December 31, 1997 financial statements in accordance with Canadian GAAP, which are substantially the same as U.S. GAAP with regard to the transactions at issue here. Solucorp confirmed this in the footnotes to its December 31, 1997 financial statements, stating that there were no differences to report between Canadian and U.S. GAAP with regard to its financial statements as the differences were not considered significant. Accordingly, the requirements of U.S. GAAP are set forth below, with citations to the comparable Canadian GAAP provisions (signified by the citations to the Canadian Institute of Chartered Accountants Handbook ("CICA Handbook")).
a. GAAP governing recognition of Smart license fees
GAAP requires that persuasive evidence of an arrangement must exist before revenue can be recognized. Statement of Position 97-2; CICA Handbook § 1000.21. In order for revenue to be recognized, it must be earned and realized or realizable. Statement of Financial Accounting Concepts No. 5, Recognition and Measurement in Financial Statements of Business Enterprises ("CON 5"), ¶ 83; CICA Handbook §§ 1000.47, 3400.06, 3400.08-.09. Revenues are earned when the reporting entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. CON 5, ¶ 83; CICA Handbook § 3400.06, 3400.08-.09. If collectibility is not reasonably assured, revenues should be recognized on the basis of cash received. CON 5, ¶ 84g; see also Accounting Research Bulletin No. 43 ("ARB 43"), Ch. 1A, ¶ 1; Accounting Principles Board Opinion No. 10 ("APB 10"); CICA Handbook § 3400.16. If payment is subject to a significant contingency, revenue recognition is improper. Statement of Financial Accounting Standards No. 5 ("SFAS 5"), Accounting for Contingencies; CICA Handbook § 3400.06.
b. Solucorp's nonconformance with GAAP
Solucorp's accrual of at least $590,910 in Smart license fees as revenue during the six-month transition period ended December 31, 1997 was not in conformity with GAAP. First, Solucorp could not claim to have earned license fees for a period during which no agreement between the parties existed. SOP 97-2; CON 5, ¶ 83; CICA Handbook § 1000.21, 3400.16. Second, collectibility of the license fees was not reasonably assured as of December 31, 1997. CON 5, ¶ 84g; ARB 43, Ch. 1A, ¶ 1; APB 10; CICA Handbook § 3400.16.
2. The Failure to Audit in Accordance with GAAS
Section 13a-10 of Regulation S-X [17 C.F.R. § 240.13a-10] requires that financial statements contained in a report with respect to a transition period of six months or longer must be audited in accordance with generally accepted auditing standards ("GAAS"). This section further requires that an accountant's audit report must state "whether the audit was made in accordance with [GAAS]." MacKay undertook to conduct its audit of Solucorp's financial statements for the six-month transition period ended December 31, 1997 in accordance with Canadian GAAS (signified by "CICA Handbook § __").
a. GAAS governing the audit of Solucorp's financial statements
An auditor must maintain an attitude of professional skepticism when performing audit procedures and gathering and analyzing audit evidence. CICA Handbook § 5135.06. An auditor must also obtain sufficient appropriate audit evidence to afford a reasonable basis for an opinion regarding the financial statements under audit (CICA Handbook § 5100.02), and cannot rely solely on management representations. CICA Handbook § 5300.26.
b. The failure to audit Solucorp's December 31,
1997 financial statements in accordance with GAAS
The audit of Solucorp's December 31, 1997 financial statements was not conducted in conformity with GAAS. Ohlhauser believed that Solucorp had materially misstated its September 30, 1997 financial statements and had backdated the final license agreement with Smart to September 15, 1997. Management's misrepresentations that the license agreement had in fact been finalized, though not signed, on September 15, 1997 dissuaded Ohlhauser from pursuing the issue further.7 His efforts to obtain competent evidential matter on collectibility were also stymied, with Herman refusing outright to procure information on Smart's financial condition. At the conclusion of the audit, Ohlhauser noted that there was limited evidence to indicate that the parties were complying with the terms of the agreement and no evidence that Smart had the ability to pay license fees, further observing that Solucorp had no recourse for collection if Smart did not pay.
Any reliance placed by Ohlhauser on management's expectation of offsets was misplaced. First, the possibility of offsets was contingent on continued demand for calcium sulfide, which, in turn, was contingent on securing remediation jobs using MBS. Ohlhauser was sufficiently aware of this to observe in his April 9, 1998 memo to Herman that, "[i]f there was an inference that your collection might be dependent on Smart developing future business and sales [from] the agreement, then I think [the] SEC would only allow revenues to be recorded as received. . . ." Second, an auditor cannot rely solely on management's representations, but is required under GAAS to obtain corroborative evidential matter.
In the context of all that was known to him, Ohlhauser's issuance of an unqualified audit report falsely stating that Solucorp's December 31, 1997 financial statements presented fairly, in all material respects, the financial position of the company in conformity with GAAP and that MacKay audited those financial statements in accordance with GAAS was improper. He recklessly failed to exercise professional skepticism and to gather competent evidential matter necessary to afford a reasonable basis for his audit opinion.
On the basis of this Order and the Respondent's Offer, the Commission finds that:
A. Ohlhauser engaged in improper professional conduct for purposes of Rule 102(e)(1)(ii) of the Commission's Rules of Practice; and
B. on January 16, 2003, the United States District Court for the Southern District of New York entered a final judgment permanently enjoining Ohlhauser from violating Exchange Act Section 10A.
In connection with this proceeding and any related judicial or administrative proceeding or investigation commenced by the Commission or to which the Commission is a party, the Respondent undertakes to: (i) produce documents within his possession, custody or control and provide interviews at the request of the Commission staff; (ii) accept service by mail or facsimile transmission of subpoenas for documents or testimony at depositions, hearings or trials; (iii) in connection with such subpoena, waive the territorial limits on service contained in Fed. R. Civ. Proc. 45 or applicable local rules for such subpoenas, and waive the requirements of Fed. R. Civ. Proc. 28; (iv) appoint Andrew Tretter of the law firm of McDonough Marcus Cohn Tretter Heller & Kanca, L.L.P. as agent to receive such service; and (v) give truthful and accurate information and testimony and not assert any evidentiary or other privilege other than the attorney-client and work product privileges.
In determining whether to accept the Offer, the Commission considered these undertakings.
Accordingly, IT IS HEREBY ORDERED, effective immediately that:
(a) Ohlhauser, 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") or an equivalent Canadian organization that includes or is supplemented by peer review, concurring partner review, continuing professional education and other membership requirements that provide appropriate quality controls over an accounting and auditing practice, as long as he appears or practices before the Commission as an independent accountant;
(b) Ohlhauser, or the firm with which he is associated, 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 or equivalent Canadian organization; and
(c) as long as Ohlhauser appears or practices before the Commission as an independent accountant, he will remain either a member of or associated with a member firm of the SEC Practice Section or equivalent Canadian organization and will comply with all applicable SEC Practice Section or equivalent Canadian organization requirements, including all requirements for periodic peer reviews, concurring partner reviews, and continuing professional education.
By the Commission.
Jonathan G. Katz
|1|| Rule 102(e) provides, in pertinent part:
(1) The Commission may . . . 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 . . . to have engaged in . . . (ii) improper professional conduct.
(3)(i) The Commission, with due regard to the public interest and without preliminary hearing, may, by order, . . . suspend from appearing or practicing before it any . . . accountant . . . who has been by name:
(A) [p]ermanently enjoined by any court of competent jurisdiction, by reason of his . . . misconduct in an action brought by the Commission, from violating or aiding and abetting the violation of any provision of the Federal securities laws or of the rules and regulations thereunder. . . .
(iv) . . . A person who has consented to the entry of a permanent injunction . . . without admitting the facts set forth in the complaint shall be presumed for all purposes under this paragraph (e)(3) to have been enjoined by reason of the misconduct alleged in the complaint.
|2||The findings herein are not binding on anyone other than the Respondent.|
|3||In Canada, a C.A. is the professional equivalent of a Certified Public Accountant in the United States.|
|4||In fact, as of December 18 and 19, 1997, when Ohlhauser spoke with Herman about his concerns, Smart had paid only $150,000, which had been wired on October 21, 1997. In an October 22, 1997 press release, Solucorp had characterized the payment as "confirmation of Smart's commitment to obtaining an exclusive license to market and apply" MBS in China.|
|5||Under the terms of the final agreement, Smart was required to pay the first year license fee in installments as follows: $200,000 by each of July 31, 1997, September 30, 1997, and November 30, 1997; $400,000 by January 31, 1998; and $500,000 by each of March 31, 1998 and May 31, 1998. The agreement set forth this payment schedule notwithstanding that as of the purported date of the agreement, September 15, 1997, no payment had been made in July; as of mid-November 1997, when the parties met in China to finalize the agreement, no payment had been made in September; and as of December 30, 1997, when the written agreement was finalized and executed, no payment had been made in November.|
|6||Had Ohlhauser obtained the only audited financial statements available for Smart at the time, which related to the fiscal year ended March 31, 1997, he would have seen that the company was dormant as of the end of that period and had assets of only $2,850 HK.|
|7||Ohlhauser's alleged failure to take appropriate steps in accordance with Exchange Act Section 10A on becoming aware of the backdating is the subject of a separately instituted civil injunctive action, SEC v. Solucorp Industries, Ltd., et al., 99 Civ. 11965 (S.D.N.Y.), in which senior management is also alleged to have lied to Ohlhauser about the date as of when the license agreement was finalized. On January 16, 2003, the United States District Court for the Southern District of New York entered a final judgment in that action permanently enjoining Ohlhauser from future violations of Exchange Act Section 10A. Ohlhauser consented to entry of the judgment without admitting or denying the allegations of the Commission's complaint. See Lit. Rel. No. 17951 (January 27, 2003).|
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