SECURITIES EXCHANGE ACT OF 1934
Release No. 49997 / July 9, 2004
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 2054 / July 9, 2004
ADMINISTRATIVE PROCEEDING
File No. 3-11542
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In the Matter of Michael Karlins, CPA, Respondent. |
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ORDER INSTITUTING PUBLIC ADMINISTRATIVE PROCEEDINGS PURSUANT TO RULE 102(e) OF THE COMMISSION'S RULES OF PRACTICE, MAKING FINDINGS, AND IMPOSING REMEDIAL SANCTIONS |
I.
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative proceedings be, and hereby are, instituted pursuant to Rule 102(e)(1) of the Commission's Rules of Practice [17 C.F.R. § 201.102(e)(1)] against Michael Karlins, a certified public accountant ("Karlins" or "Respondent").1
II.
In anticipation of the institution of these proceedings, Respondent has submitted an Offer of Settlement (the "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, and without admitting or denying the findings herein, except as to the Commission's jurisdiction over him and the subject matter of these proceedings, Respondent consents to the entry of this Order Instituting Public Administrative Proceedings Pursuant to Rule 102(e) of the Commission's Rules of Practice, Making Findings, and Imposing Remedial Sanctions ("Order"), as set forth below.
III.
On the basis of this Order and Respondent's Offer, the Commission finds2 that:
A. Michael Karlins, 45, of The Woodlands, Texas, is a certified public accountant licensed in Texas since 1983. Karlins was a partner and shareholder of Karlins, Arnold & Corbitt, P.C. ("KAC"), an accounting firm located in The Woodlands, Texas, that issued an audit report dated March 9, 1999, containing an unqualified opinion on the financial statements of Unistar Financial Service Corp. ("Unistar") for the period ended December 31, 1998. The KAC audit report was included in Unistar's Form 10-KSB filed March 31, 1999. Karlins was the engagement partner for KAC's audit of Unistar's 1998 financial statements.
B. Unistar, a Delaware corporation headquartered in Dallas, Texas, was engaged in the insurance and financial services business. Unistar filed its 1998 annual report on Form 10-KSB with the Commission, pursuant to Section 15(d) of the Securities Exchange Act of 1934 and Rule 15d-1 thereunder.3
C. In September 1998, Unistar acquired the assets and operations of U.S. Fidelity Holding Corp. ("U.S. Fidelity"), a Texas insurance holding company, from Rockford Partners, Ltd. ("Rockford"), a Bermuda-based British Virgin Islands company, in exchange for $100 million of Unistar stock.
D. At the time of Unistar's acquisition of U.S. Fidelity, Unistar's chief executive officer, Marc A. Sparks ("Sparks"), was a controlling shareholder of Unistar and controlled Rockford. Also, Unistar's chief executive officer and its president, F. Jeffrey Nelson ("Nelson"), held executive positions in U.S. Fidelity both before and after the acquisition, and together had previously owned all of the shares of U.S. Fidelity. Sparks and Nelson transferred their U.S. Fidelity interest to Rockford in purported satisfaction of preexisting obligations. Unistar, U.S. Fidelity and Rockford were therefore under common control and were related parties.
E. In connection with the U.S. Fidelity transaction, Unistar recorded approximately $74.5 million of goodwill, which it characterized as "customer lists" on its balance sheet. The customer lists/goodwill was materially overstated. First, since U.S. Fidelity was a related party under common control with Unistar, Unistar should not have recorded goodwill in connection with the U.S. Fidelity acquisition.4 Second, Unistar assigned an inflated value to the assets acquired in the U.S Fidelity acquisition. Consequently, Unistar failed to comply with generally accepted accounting principles ("GAAP") and materially overstated its assets in its December 31, 1998, financial statements.
F. Unistar's 1998 financial statements also included other significant errors. In particular, the stockholders' equity section of Unistar's balance sheet included treasury stock when, in fact, almost 85% of that treasury stock had been issued to another company. Furthermore, the financial statement footnotes reported unaudited pro forma results that incorrectly referred to gross written premiums as revenues, thus significantly overstating the company's pro forma revenues.
G. The KAC audit report stated that the firm conducted its audit of Unistar's 1998 financial statements in accordance with generally accepted auditing standards ("GAAS") and that the financial statements presented fairly Unistar's financial position and results of operations in conformity with GAAP. In fact, however, the financial statements were not in conformity with GAAP, and Respondent did not conduct the audit of Unistar's financial statements in compliance with GAAS. Respondent failed to obtain sufficient competent evidential matter, act with due professional care, or exercise adequate professional skepticism.5
H. In particular, although Respondent purportedly identified the U.S. Fidelity transaction as a major focus of the audit, he failed to give it heightened scrutiny. Respondent instead relied on oral representations from Unistar's management that the U.S. Fidelity transaction did not involve a related party, even though statements in the company's SEC filings significantly undermined those representations. Specifically, in September and October 1998 filings, Unistar disclosed that Sparks and Nelson were executive officers of U.S. Fidelity both before and after the transaction, that they had owned all of the stock of U.S. Fidelity, and that, "immediately prior" to the transaction, they transferred their shares of U.S. Fidelity to Rockford in satisfaction of preexisting obligations. Respondent, however, intentionally or recklessly ignored this information and failed to obtain sufficient competent evidential matter as to the ownership and control of Rockford. Respondent also failed to obtain sufficient competent evidential matter and to exercise adequate due professional care or professional skepticism in connection with Unistar's valuation of its customer lists/goodwill.
I. Respondent also failed to obtain sufficient competent evidential matter to verify the September 30, 1998, asset and liability valuations for U.S. Fidelity and its subsidiaries, even though U.S. Fidelity and two of its three subsidiaries had never been audited. In addition, Respondent failed to verify that Unistar's treasury stock listed on the audited balance sheet was actually issued to and owned by the company, even though Karlins falsely noted on his audit program that he had performed this procedure. Finally, Respondent allowed Unistar to include in its financial statement footnotes unaudited pro forma results that misleadingly referred to gross written premiums as revenues, when he should have requested that Unistar show that the so-called revenues were actually gross written premiums.6
J. Based on the foregoing, Respondent engaged in improper professional conduct pursuant to Rule 102(e)(1)(ii) of the Commission's Rules of Practice by:
1. intentional or knowing conduct, including reckless conduct, that resulted in a violation of applicable professional standards;
2. a single instance of highly unreasonable conduct that resulted in a violation of applicable professional standards in circumstances in which he knew, or should have known, that heightened scrutiny was warranted; and
3. 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.
IV.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Respondent Karlin's Offer.
Accordingly, it is hereby ORDERED, effective immediately, that:
A. Karlins is denied the privilege of appearing or practicing before the Commission as an accountant.
B. After three years from the date of this order, Respondent may request that the Commission consider his reinstatement by submitting an application (attention: Office of the Chief Accountant) to resume appearing and practicing before the Commission as:
1. a preparer or reviewer, or a person responsible for the preparation or review, of any public company's financial statements that are filed with the Commission. Such an application must satisfy the Commission that Respondent's work in his practice before the Commission will be reviewed either by the independent audit committee of the public company for which he works or in some other acceptable manner, as long as he practices before the Commission in this capacity; and/or
2. an independent accountant. Such an application must satisfy the Commission that:
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(a). Respondent, or the public accounting firm with which he is associated, is registered with the Public Company Accounting Oversight Board ("Board") in accordance with the Sarbanes-Oxley Act of 2002, and such registration continues to be effective;
(b). Respondent, or the registered public accounting firm with which he is associated, has been inspected by the Board and that inspection did not identify any criticisms of or potential defects in the respondent's or firm's quality control system that would indicate that the respondent will not receive appropriate supervision or, if the Board has not conducted an inspection, 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 former SEC Practice Section of the American Institute of Certified Public Accountants Division for CPA Firms or an organization providing equivalent oversight and quality control functions;
(c). Respondent has resolved all disciplinary issues with the Board, and has complied with all terms and conditions of any sanctions imposed by the Board (other than reinstatement by the Commission); and
(d). The Respondent acknowledges his responsibility, as long as Respondent appears or practices before the Commission as an independent accountant, to comply with all requirements of the Commission and the Board, including, but not limited to, all requirements relating to registration, inspections, concurring partner reviews and quality control standards.
C. The Commission will consider an application by Respondent to resume appearing or practicing before the Commission provided that his state CPA license is current and he has resolved all other disciplinary issues with the applicable state boards of accountancy. However, if state licensure is dependant on reinstatement by the Commission, the Commission will consider an application on its other merits. The Commission's review may include consideration of, in addition to the matters referenced above, any other matters relating to Respondent's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
Secretary
Endnotes
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 be lacking in character or integrity or to have engaged in unethical or improper professional conduct ; (iv) with respect to persons licensed to practice as accountants, "improper professional conduct: under §201.102(e)(1)(ii) means: (A) intentional or knowing conduct, including reckless conduct, that results in a violation of applicable professional standards; or (B) either of the following two types of negligent conduct: (1) a single instance of highly unreasonable conduct that results in a violation of applicable professional standards in circumstances in which an accountant knows, or should know, that heightened scrutiny is warranted. (2) 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.