UNITED STATES OF AMERICA
In the Matter of
DAVID DECKER, CPA and
THEODORE FRICKE, CPA
| ORDER INSTITUTING PUBLIC
PROCEEDINGS PURSUANT TO 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
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative and cease-and-desist proceedings be, and hereby are, instituted against David Decker, CPA ("Decker") and Theodore Fricke, CPA ("Fricke") (together referred to as "Respondents") pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 102(e)(1)(ii) and (iii) of the Commission's Rules of Practice.1
In anticipation of the institution of these proceedings, Respondents Decker and Fricke have submitted Offers of Settlement (the "Offers") 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 them and the subject matter of these proceedings, Respondents consent to the entry of this Order Instituting Public Administrative and Cease-and-Desist Proceedings Pursuant to 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 Respondents' Offers, the Commission finds2 that:
A. RESPONDENTS AND RELATED PARTIES
1. Decker, age 62, a resident of Dunwoody, Georgia, is licensed as a certified public accountant ("CPA") in Georgia. In November 1996, he joined BKR Metcalf Davis ("Metcalf Davis") as a senior manager. He became a non-equity partner of the firm in 2000. In Metcalf Davis' audit of Chancellor Corporation's ("Chancellor") 1998 financial statements, he was responsible for conducting a review of the audit workpapers as part of the firm's quality control function. He also performed audit steps to determine the appropriate date of consolidation of Chancellor's results with that of a subsidiary it acquired during 1998.
2. Fricke, age 53, a resident of Lawrenceville, Georgia, is a CPA licensed in Georgia. He was a partner of Metcalf Davis from 1989 until August 1999. He is currently self-employed as the sole partner in Fricke & Associates, P.C., a certified public accounting firm. Fricke served as the concurring partner in Metcalf Davis's audit of Chancellor's 1998 financial statements.
3 Chancellor Corporation is a Massachusetts corporation with headquarters in Boston, Massachusetts, which was principally engaged in buying, selling and leasing new and used transportation equipment such as trailers and trucks. From 1983 to 2001, Chancellor's common stock was registered with the Commission pursuant to Section 12(g) of the Exchange Act. On March 9, 2001, Chancellor filed a Form 15 terminating its Commission registration because it had fewer than 300 shareholders. In August 2001, one of the firm's creditors filed an involuntary bankruptcy action against Chancellor in U.S. Bankruptcy Court in the District of New Jersey and the court appointed a receiver to liquidate the company's assets.
4. BKR Metcalf Davis (formerly known as Metcalf, Rice, Fricke and Davis), located in Atlanta, Georgia, is an accounting firm that provides professional services including auditing and tax work. It is a member of BKR International Association, a network of affiliated accounting firms. Metcalf Davis was Chancellor's independent auditor from February 1999 to October 2001.
5. Gregory Davis, age 50, is a certified public accountant and resides in Lilburn, Georgia. He has been a partner of Metcalf Davis since 1990. Davis served as the engagement partner in the firm's audits of Chancellor's 1998 and 1999 financial statements as well as the restatements in 2000 of its previously filed 1998 and 1999 financial reports.
6. Respondents Decker and Fricke engaged in improper professional conduct as auditors and caused Chancellor, the company they audited, materially to overstate its revenue, income and assets for 1998 in its Form 10-KSB filed with the Commission. Decker, the audit manager, and Fricke, the concurring audit partner, allowed improper accounting in two significant areas in connection with Chancellor's acquisition of a subsidiary.
7. First, along with Chancellor's management and the audit engagement partner, Decker and Fricke caused Chancellor improperly to account for the acquisition of the subsidiary as a business combination in its 1998 year-end financial statements, although the acquisition agreement was not consummated until 1999. This premature consolidation of the subsidiary's financial results caused Chancellor to overstate its 1998 revenue by $19 million or 177%. Decker and Fricke did not object to the 1998 consolidation although it did not conform with generally accepted accounting principles ("GAAP"). Their position was based on a document which was produced in circumstances indicating that it might have been fabricated by Chancellor's management. Respondents failed to inform Chancellor's audit committee of the possibility of management fraud.
8. Second, in connection with Chancellor's acquisition of its subsidiary, Decker and Fricke, along with Chancellor's management and the engagement partner, caused Chancellor to record a fee of $3.3 million to an entity controlled by the CEO of Chancellor, for purported acquisition consulting services which were never rendered. The baseless payment was improperly capitalized rather than being reported as an expense. As a result, Chancellor reported assets of $29.5 million rather than $26.2 million.
9. By their conduct, Decker and Fricke willfully violated Section 10A of the Exchange Act and caused Chancellor's violations of Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder; and engaged in improper professional conduct under Rule 102(e)(1) of the Commission's Rules of Practice.
Chancellor's Premature MRB Consolidation and
Improper Fee Payment to Related Party
10. In August 1998, Chancellor entered into a letter of intent to acquire a subsidiary, MRB. The acquisition closed on January 29, 1999. Chancellor included MRB's financial results in Chancellor's 1998 reported results.
11. Under GAAP, in order to make the MRB acquisition effective and consolidation proper as of August 1998, it was necessary that there be a written agreement giving Chancellor control over MRB as of that date. In early February 1999, Chancellor gave the company's auditors at the time (the firm which Metcalf Davis later replaced ("predecessor auditors")) a purported management agreement, backdated to August 1, 1998, which Chancellor's management claimed gave Chancellor control over MRB's affairs. The predecessor auditors, however, found the terms of this agreement insufficient to support the conclusion that Chancellor controlled MRB as of August 1998.
12. The predecessor auditors informed Chancellor's CEO, Brian Adley, in a memorandum dated February 8, 1999 and again at a board meeting on February 12, 1999, that consolidation of MRB's 1998 financial results with Chancellor's did not comport with GAAP. They provided accounting literature that outlined the criteria to be satisfied in order for Chancellor properly to consolidate MRB's 1998 financial with its own.
13. Upon receiving this information, Adley directed Chancellor's acting CFO to create another document, the "First Amendment" to Chancellor's management agreement with MRB, which was falsely dated August 17, 1998, in order to meet the criteria for consolidation. The First Amendment provided that Chancellor would assume control of MRB's daily operations in August 1998 and that from then on MRB was required to submit significant decisions to Chancellor for approval.
14. The two controlling shareholders of MRB never saw or approved the First Amendment. Its terms were inconsistent with the actual relations between the two companies before the January 1999 acquisition. Control did not in fact pass to Chancellor until after the January 1999 closing.
15. The substance of the First Amendment to the Management Agreement did not cause the predecessor auditors to change their position that Chancellor could only properly account for the MRB acquisition as of January 1999. On February 25, 1999, Chancellor dismissed the predecessor auditors.
16. After dismissing the predecessor auditors, Chancellor engaged Metcalf Davis to conduct the independent audit of its 1998 financial statements. Chancellor provided the backdated Management Agreement and the fabricated First Amendment to Metcalf Davis.
17. During March 1999, Chancellor gave Metcalf Davis additional documents purportedly demonstrating Chancellor's control of MRB during 1998. These documents included letters and memoranda fabricated in March 1999 but bearing dates during 1998, which purportedly instructed MRB's officers to act on various business matters.
18. In connection with its acquisition of MRB, Chancellor improperly recorded $3.3 million in consulting fees payable to Vestex Capital Corporation ("Vestex"), a firm wholly owned by Chancellor's CEO Adley. The fees were purportedly for work by Vestex in finding, introducing and negotiating the MRB acquisition and securing financing for it. In fact, however, there was no basis for the consulting fees because Vestex did not find or negotiate the MRB acquisition or provide any other significant services to Chancellor in connection with the MRB acquisition.
19. In April 1999, Adley directed fabrication of documents to support the $3.3 million Vestex fee. The fabricated documents included a Chancellor board resolution dated September 11, 1998 directing Chancellor to pay Vestex $3.25 million at the closing of the MRB acquisition for its services in connection with the acquisition; a promissory note from Chancellor payable to Vestex in the amount of $3.475 million; and a consulting agreement between Chancellor and Vestex. The fabricated documents were given to Metcalf Davis.
20. Davis, the firm's engagement partner, requested documents showing that consulting services had actually been rendered, including bills and time records. Chancellor never provided any such documents to anyone at Metcalf Davis.
21. Chancellor recorded the $3.3 million Vestex fee as a capitalized asset of Chancellor, rather than as an expense. Under GAAP, "incremental costs" payable to an outside consultant in a business combination may be capitalized, but fees payable to employees or entities controlled or owned by employees, such as Vestex, are internal costs that must beexpensed. If Chancellor had recorded the fee as an expense, it would have reported a net loss of $2.45 million for 1998. By capitalizing the fee, Chancellor was able to report a net gain of $850,000.
Respondents' Conduct in the Chancellor Audit
22. In Metcalf Davis' independent audit of Chancellor's 1998 financial results, Decker conducted audit tests and accounting research to substantiate the MRB acquisition date. He also served as Metcalf Davis' "impartial review manager" for the audit. In his role as impartial review manager, Decker had operational responsibility for ensuring that the way in which the audit was conducted complied with Metcalf Davis' quality control policies and generally accepted auditing standards (GAAS).
23. Decker determined that recording the MRB acquisition as of August 1, 1998 was appropriate under GAAP because Chancellor had the necessary control of MRB on that date. He relied on the Management Agreements as the evidence of Chancellor's control. Decker knew that the predecessor auditors had been dismissed. He also knew that in the predecessor auditors' view, 1998 consolidation of MRB's financial results was contrary to GAAP. In addition, Decker knew that the First Amendment to the Management Agreement was not referred to in the papers he received from the predecessor auditors. He telephoned the engagement partner of the predecessor auditors, who expressed skepticism about the date the First Amendment was created.
24. Decker never questioned Adley or any other Chancellor representative about the authenticity of the First Amendment. Decker never confirmed the existence, date or terms of the First Amendment with the shareholders of the acquired company, MRB. He never communicated any doubt about the authenticity of the document to Chancellor's audit committee.
25. During his quality control review of the audit workpapers, Decker questioned the $3.3 million fee to Vestex. Decker knew that Chancellor in its Form 10-KSB for 1997 had disclosed that $1.14 million in recorded fees to Vestex had been reversed that year. He had reviewed the prior auditors' draft management letter, which addressed a lack of contemporaneous documentation for related-party transactions with Vestex. He knew that heightened scrutiny of 1998 related-party transactions such as the $3.3 million Vestex fee was therefore warranted.
26. Decker noted that the workpapers he reviewed for the 1998 audit contained no documentation to support the nature or value of the supposed services for which the fee was being charged. Decker raised the issue with Davis, the engagement partner, but took no further action when Davis did nothing. Decker also questioned whether the fee should be capitalized rather than expensed, but took no action to determine the correct accounting treatment. Decker signed off as impartial review manager, indicating that the audit comported with GAAS.
27. Fricke served as the concurring partner for the Chancellor audit. He did not conduct any research on the auditing requirements or accounting rules relevant to the issues noted in the audit workpapers. With respect to the MRB acquisition date, prior to the release of the audit report, Fricke reviewed workpapers documenting the audit work performed by Decker on the acquisition date. These workpapers included a memo from Decker to Davis discussing the issue concerning authenticity of the First Amendment. Fricke was also aware of the disagreement between Chancellor and the prior auditors about the correct date. Nevertheless, Fricke relied on the conclusions of Davis and Decker, although he either knew or was reckless in not knowing that audit procedures had not been extended to resolve the significant audit issues documented in the workpapers.
28. Before the audit report was released, Fricke was made aware of issues relating to the Vestex fee, including the lack of documentation to support it. From his review of Chancellor's Form 10-KSB for 1997, Fricke knew that fees to Vestex had been reversed that year. Despite his knowledge that heightened scrutiny of 1998 related-party transactions was therefore warranted, Fricke did not examine the audit workpapers concerning 1998 related-party transactions including the $3.3 million Vestex fee. Instead, he simply asked Davis if there were any significant related-party issues that he needed to address and accepted the assurance that there were none. Fricke reviewed the draft Form 10-KSB for 1998, but did not suggest any additions or changes to the related-party disclosure.
29. Fricke raised no questions about Davis' decision to capitalize the Vestex fee, although he reviewed the financial statements which reflected the material impact capitalization would have on Chancellor's reported financial results. He did not do any research to determine whether capitalization was consistent with GAAP.
Decker and Fricke Caused Chancellor's Filing of Materially
Misleading Financial Results for 1998
30. On April 16, 1999, Chancellor filed a Form 10-KSB for the year ended December 31, 1998. In the financial statements included, Chancellor accounted for its acquisition of MRB as of August 1, 1998, and consolidated its financial results with those of MRB. As a result, Chancellor reported annual revenues of $29,639,000, 177% higher than the $10,708,000 revenue figure for Chancellor without the MRB consolidation; annual net income of $850,000, rather than $524,000 (62% higher); and assets of $29,569,000, rather than $8,186,000 (261% higher).
31. This accounting treatment did not comport with GAAP because during 1998 Chancellor did not have the effective control of MRB needed to justify accounting for MRB's acquisition as of 1998.
32. Chancellor's Form 10-KSB falsely represented that Adley's Vestex entity hadhandled the acquisition of MRB and provided consulting, financing and other services in connection with the acquisition. It falsely stated that as part of those services Vestex had obtained $3.5 million in financing for Chancellor.
33. GAAP requires that financial statements include disclosure of material related-party transactions, including information deemed necessary to gain an understanding of the effects of the transactions on the financial statements. The transaction between Chancellor and Vestex was a related-party transaction and GAAP required disclosure of the specific facts relating to the $3.3 million fee.
34. The Form 10-KSB did not comport with GAAP because, although it disclosed that Chancellor incurred costs of $3.405 million in acquiring MRB, it did not disclose that these costs consisted entirely of consulting fees charged by Vestex. It did not disclose the lack of any basis for the fees.
35. Although not separately identified, the $3.3 million Vestex fee from Chancellor was included in Chancellor's reported financial results. The fee should not have been included in any form as it had no basis. Even if it had been a legitimate fee, it should have been recorded as an expense as required by GAAP. The fee was improperly capitalized. As a result, Chancellor overstated its assets at year-end 1998 by 11%.
36. On April 14, 1999, Davis signed and authorized issuance of the Metcalf Davis auditors' report for Chancellor's 1998 year-end financial results. The report falsely stated that Chancellor's financial statements were fairly presented in accordance with GAAP and that Metcalf Davis' audit had been performed in accordance with GAAS. As independent review manager, Decker approved these representations.
37. Fricke signed the supervisory approval document authorizing issuance of the Metcalf Davis auditors' report on April 30, 1999, more than two weeks after Metcalf Davis had issued its unqualified opinion with respect to Chancellor's 1998 financial results and two weeks after Chancellor had filed its Form 10-KSB in which the opinion was included. After completing his review, he made no objections to the unqualified opinion.
Decker and Fricke Engaged in Improper Professional Conduct
38. Decker and Fricke violated applicable professional standards in connection with the audit of Chancellor's 1998 financial results, which did not comport with GAAS. They did so knowingly or recklessly, or acting highly unreasonably in circumstances where they knew or should have known that heightened scrutiny was warranted.
39. GAAS requires that auditors conducting an audit exercise due professional care and maintain a proper level of professional skepticism. Auditing standards also require auditors to obtain sufficient competent evidential matter to afford a reasonable basis for an opinionregarding the financial statements under audit. Under GAAS, representations from management are not a substitute for the application of auditing procedures necessary to afford a reasonable basis for the auditor's opinion. When an auditor becomes aware of information concerning a possible illegal act, the auditor should obtain an understanding of the nature of the act, the circumstances in which it occurred, and sufficient other information to evaluate the effect on the financial statements. An auditor has a responsibility to perform an audit to obtain reasonable assurance that material misstatements in financial statements due to fraud are detected. If management does not provide satisfactory information that there has been no illegal act, GAAS requires additional audit steps to be performed. These include confirming a significant transaction with other parties to the transaction.
40. With respect to related-party transactions, GAAS requires that auditors must obtain sufficient evidence to understand the purpose, nature, extent and financial statement effect of the transactions. They must plan and perform the audit to obtain reasonable assurance as to whether the financial statements are free of material misstatements. If the auditor is unable to obtain sufficient competent evidential matter or determines that the financial statements do not comport with GAAP, GAAS provide that the auditor should express a qualified or an adverse opinion and should provide the information in his reports.
41. Decker failed to exercise due professional care or obtain sufficient competent evidential matter to verify that the MRB acquisition date was properly recorded. He knew that management's insistence on a 1998 acquisition date resulted in a significant increase in reported revenues, so that heightened scrutiny of the date was needed. However, he failed to extend the audit procedures to confirm with the MRB shareholders the existence of control in 1998.
42. Decker failed to critically assess documents he suspected might have been fabricated by Chancellor's management. He did not even question anyone at Chancellor about the authenticity of the documents. In spite of his concern that the documents might have been fabricated by Chancellor's management, he relied on the documents as support for the 1998 acquisition date. He failed to maintain a proper level of professional skepticism, as required by GAAS.
43. Decker further failed to comply with GAAS when he failed to report to Chancellor's audit committee the possibility that the company's senior management had fraudulently created the First Amendment.
44. Decker further failed to comply with GAAS in connection with his review of the accounting for Chancellor's fee to Vestex. He failed to obtain sufficient evidential matter to support recording the Vestex fee, particularly evidence sufficient to understand the purpose, nature, extent and financial statement effect of this related-party transaction, as required by GAAS. He also failed to exercise the required professional skepticism.
45. Decker knew from Chancellor's 1997 Form 10-KSB and his review of the prior auditors' management letter that fees to Vestex had been reversed in the prior year because they were not verifiable. He ignored indications that the 1998 Vestex fees were similarly unsupportable. He knew that Chancellor's management had not responded to Davis' requests for documents evidencing the services for which the fees were charged. He improperly approved reliance on management's unsupported oral representations that the services had been rendered rather than following GAAS by extending audit procedures to Vestex.
46. Decker knew that capitalizing the Vestex fee resulted in Chancellor materially increasing its reported assets. He recklessly disregarded specific GAAP requirements stating that these costs should be expensed. He thereby failed to exercise due professional care.
47. As concurring reviewer, Fricke failed to perform his duty to make an objective independent review of material accounting, auditing or reporting issues to ensure conformance with GAAP and GAAS. He failed to follow up on noted or obvious deficiencies, which if, properly pursued, would have resulted in a conclusion that the audit had not been conducted in accordance with GAAS and that the financial statements were not fairly presented in conformity with GAAP.
48. Fricke knew or was reckless in not knowing from his review of the workpapers regarding the MRB acquisition date that audit procedures had not been extended as required to resolve the acquisition date issues, including whether key documents were authentic.
49. Although Fricke knew that related-party transactions had been identified as a high risk audit area, he did not review any related-party workpapers. He never questioned or independently ascertained whether sufficient competent evidence had been obtained to support the Vestex fee and whether its disclosure in Chancellor's Form 10-KSB was complete and adequate. He never considered whether the Vestex fee should be capitalized rather than expensed under GAAP.
50. By his conduct, Fricke failed to exercise due professional care. He failed to observe the standards of reporting. As concurring reviewer, Fricke knew or was reckless in not knowing that insufficient audit evidence had been obtained to support an unqualified opinion. He failed to maintain a proper level of professional skepticism; failed to 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; and failed to obtain sufficient evidence to understand the purpose, nature, extent and financial statement effect of related-party transactions.
Decker and Fricke Willfully Violated Section 10A of the Exchange Act
51. Decker and Fricke had information indicating that Chancellor's senior management might have fraudulently created the First Amendment to the Management Agreement in order to support Chancellor's accounting position regarding the appropriate consolidation date for MRB. They took no steps to confirm the existence of the First Amendment with the MRB shareholders in accordance with GAAS. Accordingly, they willfully violated Section 10A(a)(1) by failing to design appropriate audit procedures to determine whether or not senior management had committed fraud.
52. Decker and Fricke willfully violated Section 10A(b)(1) when they failed to inform Chancellor's audit committee of the suspected senior management fraud.
Decker and Fricke Caused Chancellor's Reporting Violations
53. By filing a materially misleading Form 10-KSB for 1998, Chancellor violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder.
54. Decker and Fricke each caused Chancellor's violations of these provisions. Decker determined that a 1998 date for the MRB acquisition was proper. He approved the improper recording of the $3.3 million Vestex fee. Fricke approved issuance of an unqualified opinion falsely representing that Chancellor's financial statements comported with GAAP and that the audit had been conducted in accordance with GAAS.
In view of the allegations made by the Division of Enforcement, the Commission deems it appropriate to impose the sanctions agreed to in Respondents' Offers.
Accordingly, IT IS HEREBY ORDERED, effective immediately, 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") or an organization providing equivalent oversight and quality control functions ("equivalent organization");
(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 or equivalent organization; and
(c) As long as Respondent 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 organization, and will comply with all applicable SEC Practice Section or equivalent 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)(1)(ii) provides, in relevant part, that:
Rule 102(3)(1)(iii) provides, in relevant part, that:
|2||The findings herein are made pursuant to Respondents' Offers of Settlement and are not binding on any other person or entity.|
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