UNITED STATES OF AMERICA
In the Matter of
GARY L. SEIDELMAN, CPA
|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|
The Securities and Exchange Commission ("Commission") deems it appropriate that public administrative and cease-and-desist proceedings be, and hereby are, instituted against Respondent Gary L. Seidelman ("Seidelman" or "Respondent") pursuant to Section 21C of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 102(e)(1)(ii) of the Commission's Rules of Practice.1
In anticipation of the institution of these proceedings, Seidelman 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, and without admitting or denying the Commission's findings herein, except as to the Commission's jurisdiction over him and the subject matter of these proceedings, Seidelman consents 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 the Order and Seidelman's Offer, the Commission finds2 that:
1. Seidelman, age 52, resides in Batavia, Illinois. Seidelman is a partner in the Chicago office of PricewaterhouseCoopers LLP ("PwC") and a certified public accountant ("CPA") licensed in Illinois. PwC and its predecessor, Coopers & Lybrand LLP, have employed him since 1973. From 1994 to 2000, Seidelman was the engagement partner on all of the audits and interim reviews of the financial statements of Anicom, Inc. ("Anicom").
2. Anicom, a Delaware corporation based in Rosemont, Illinois, was a national distributor of wire and cable products. On July 18, 2000, Anicom announced an internal investigation into accounting irregularities and Nasdaq immediately halted trading in Anicom stock. In November 2000, Anicom issued unaudited revised revenue and pre-tax net income for the period January 1998 through March 2000. Thereafter, Nasdaq delisted Anicom stock from its national exchange. In January 2001, Anicom filed for Chapter 11 bankruptcy protection. Anicom's common stock was registered with the Commission under Section 12(g) of the Exchange Act from January 11, 1995 until November 26, 2002, when the registration was revoked pursuant to Section 12(j) of the Exchange Act.
3. PwC, whose principal offices are located in New York City, New York, was created by the merger of Price Waterhouse and Coopers & Lybrand LLP in July 1998. PwC provides audit assurance and business advisory services. PwC has numerous offices domestically and abroad, including an office in Chicago, Illinois.
4. Certain of Anicom's officers and employees (sued by the Commission in SEC v. Putnam, et al., No. 02 C 3235 (N.D. IL) and hereinafter referred to as the Anicom defendants) engaged in improper earnings management techniques that inflated Anicom's revenues by over $38 million and net income by over $20 million from the first quarter of 1998 through the first quarter of 2000.
5. Specifically, the Anicom defendants engaged in extensive improper revenue recognition. They inflated Anicom's revenues and cost of sales by causing Anicom to recognize over 66 fictitious sales transactions to at least 38 different customers. The vast majority of the fictitious sales transactions were created just prior to quarter end, when it was clear that Anicom would not meet its revenue goals. These end-of-the-quarter sales transactions were either entirely fictitious or potential orders disguised as sales. The Anicom defendants also accelerated earnings by recording sales early. This practice of recording projected or potential orders as sales transactions was inconsistent with generally accepted accounting principles ("GAAP").
6. The Anicom defendants also engaged in fraudulent accounting practices that understated expenses. Among other things, in the third quarter of 1999, they improperly used a one-time $6.1 million restructuring charge to mischaracterize operating expenses on the income statement, which was inconsistent with GAAP requirements to recognize one-time charges.
7. On July 18, 2000, Anicom announced that it was investigating possible accounting irregularities and that its 1998 and 1999 financial statements should not be relied upon.
8. In November 2000, Anicom filed a Form 8-K with the Commission reflecting unaudited revised revenue and pre-tax net income that revealed the extent to which Anicom's filings were misstated. In 1998, Anicom's revenues were overstated by $13.6 million and net income by $9.3 million, or 126% of reported profits. In 1999, Anicom's revenues were overstated by $15 million and net losses were understated by $7.3 million, or more than 70% of reported losses. In the first quarter of 2000, Anicom's revenues were overstated by $10 million and net income by $3.8 million, or 327% of reported profits.
9. During the time of the Anicom defendants' fraudulent conduct, PwC conducted the audits and interim reviews of Anicom's financial statements. Seidelman, as the engagement partner, was responsible for determining the audit strategy, ensuring that the audit was conducted in accordance with applicable professional standards, reviewing and signing off on critical areas of the audit, ensuring that the audit work was appropriately documented, and issuing the audit report.
10. PwC issued an unqualified audit report on Anicom's 1999 financial statements. PwC's unqualified audit report stated in relevant part:
"In our opinion, the consolidated financial statements … present fairly, in all material respects, the financial position of Anicom, Inc. at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States….We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement….We believe that our audits provide a reasonable basis for the opinion expressed above."
11. Contrary to the representations in PwC's audit report, Anicom's 1999 financial statements did not conform to GAAP and the audit was not conducted in accordance with generally accepted auditing standards ("GAAS") in effect at the time of the audit.
12. Seidelman engaged in improper professional conduct in connection with PwC's 1999 audit and first quarter 2000 interim review of Anicom's financial statements. His conduct was either intentional or knowing conduct, including reckless conduct, or negligent conduct, as defined in Rule 102(e)(1)(iv), which resulted in violations of applicable professional standards.
13. The engagement team began planning the 1999 audit in late fall 1999 and began the fieldwork in late January 2000.
14. GAAS' First Standard of Field Work required that audit work be adequately planned. AICPA, Codification of Statements on Auditing Standards (AU) §150.02. Particularly, GAAS provided that "in planning the audit, the auditor should consider, among other matters…conditions that may require extension or modification of audit tests, such as the risk of material error or fraud or the existence of related party transactions." AU §311.03. See also AU §316A ("Consideration of Fraud in a Financial Statement Audit"). Contrary to this standard, Seidelman failed to adequately plan the 1999 audit after he learned of several facts over a short period of time that, either standing alone or in the context of the other facts learned during that period, constituted red flags that should have alerted him to the possibility that Anicom's financial statements might be misstated due to fraud:
a. First, in or around October 1999, a former employee of Anicom alleged that Anicom management was engaging in fraudulent billing practices. Anicom retained an outside law firm to conduct an internal investigation of the allegations, which were determined to be unfounded. However, without knowing the details of the internal investigation, such as who was interviewed or the specific allegations, because it was conducted under attorney-client privilege that Anicom did not waive, Seidelman relied on the conclusions reached in the internal investigation and did not design audit procedures to provide greater assurances that Anicom's accounts receivable were not misstated.
b. Second, shortly after the internal investigation in December 1999, Seidelman received, and the engagement team placed in PwC's working papers, copies of correspondence from the Commission's enforcement staff requesting that Anicom voluntarily produce records reflecting Anicom's accounts receivable, sales journals, cash payment journals and debit and credit memoranda for certain quarters in 1998 and 1999.
c. Third, also in or around December 1999, Seidelman and a risk management partner reevaluated Anicom as "high-risk." They did this because Anicom was experiencing increased business-associated risks. First, Anicom had unexpected cash flow problems in the third quarter of 1999. Second, Anicom might not have been in compliance with covenants in agreements with its principal lenders. Third, Anicom incurred a $6.1 million restructuring charge in the same quarter. In reevaluating Anicom as high-risk, Seidelman also considered the former employee's allegations of fraud. Although the fact that Anicom was reevaluated as high-risk was documented in the working papers, the reasons underlying the reevaluation were not. Despite the high-risk reevaluation, Seidelman did not alter any of the audit procedures for the 1999 audit.
d. Finally, in January 2000, Seidelman learned of allegations of improper sales activity from another former Anicom employee. Seidelman spoke to one member of Anicom management (the Chief Financial Officer) and one of Anicom's lawyers regarding these allegations. Based on the CFO's assertions that this employee was disgruntled because he had been fired for cause and that his allegations were baseless, Seidelman dismissed the allegations. Seidelman also considered his own assessment of the employee's credibility in deciding to dismiss the allegations.
15. Despite being aware of the foregoing red flags, Seidelman failed to design audit procedures to test Anicom's accounts receivable more extensively than originally planned, or heighten his scrutiny in his audit of Anicom's accounts receivable, to obtain greater assurances that Anicom's accounts receivable were accurately stated.
16. GAAS' Third Standard of Field Work required that "Sufficient competent evidential matter is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit." AU §150.02. Seidelman failed to obtain sufficient competent evidential matter in several areas of the 1999 audit:
a. Seidelman failed to gather sufficient information and make meaningful inquiries to determine the veracity of the allegations of accounting fraud made by the former Anicom employees. Further, Seidelman failed to modify the audit procedures in light of these allegations.
b. Seidelman failed to obtain sufficient competent evidential matter regarding Anicom's accounts receivable:
(i) First, Seidelman failed to modify the audit procedures for Anicom's accounts receivable upon learning that a material amount of the balances from Anicom's U.S. operations could not be confirmed. PwC's testing of Anicom's accounts receivable for the U.S. operations included confirming the existence and accuracy of 20 customer balances totaling $14,354,505 out of $98,182,737 in accounts receivable. The testing involved calculating an error rate, which represents the percentage of balances the engagement team was unable to confirm out of the balances tested, to assess the potential for misstated balances and to determine whether additional procedures should be performed. The engagement team could not confirm $1,152,965 of the $14,354,505, translating to an error rate of 8%. Projecting 8% over the entire population of $98,182,737 indicates potentially misstated balances of $7,854,619, which was material to Anicom's financial statements. However, Seidelman neither altered the audit procedures, such as subjecting more accounts receivable balances to confirmation procedures, nor subjected the potentially misstated accounts receivable balances to further testing.
(ii) Second, in reliance on management representations that approximately $1 million in unsubstantiated sales to an Anicom customer were valid, Seidelman failed to propose an adjustment for the revenue from these sales. Despite Seidelman's and the engagement team's attempts to obtain third party evidence verifying these sales during PwC's confirmation procedures, Anicom never produced adequate evidence. Nevertheless, Seidelman permitted Anicom to recognize revenue from these unconfirmed sales to this customer, although Anicom had not met GAAP requirements for revenue recognition from these purported sales.
(iii) Third, in additional alternative procedures performed on 17 of the 20 balances for which PwC did not receive third party confirmations, Seidelman failed to verify all subsequent cash payments, totaling $9,817,038 purportedly made by customers towards their balances. GAAS require that "auditing procedures that are appropriate to the particular audit objective should be applied to each sample item." AU §350.25. However, rather than test the entire $9,817,038, e.g., by tracing payments to bank deposits, PwC tested only $2,746,487, or 28%. Despite Seidelman's knowledge of fraud allegations related to Anicom's accounts receivable, however, he did not deem it necessary to apply verification procedures to all subsequent cash payments.
c. Seidelman failed to obtain sufficient competent evidential matter regarding two items included in the $6.1 million restructuring charge incurred by Anicom in the third quarter of 1999. Consequently, Seidelman approved the inclusion of those items in the restructuring charge although they did not conform with GAAP. Anicom improperly included an almost three-year-old $625,000 note receivable that was unrelated to any aspect of the restructuring. Anicom also included a $300,000 bank waiver fee, which Anicom incurred as a result of violating its loan covenant with a bank. By paying this fee, Anicom maintained its revolving credit line, which yielded future economic benefits to Anicom. Because GAAP requires, among other things, that costs associated with a restructuring charge not benefit activities that will continue, the bank waiver fee was also improperly included.
d. Seidelman failed to ensure that documentation in the working papers provided sufficient competent evidential matter to support PwC's unqualified audit report. GAAS provided that "working papers are records kept by the auditor of the procedures applied, the tests performed, the information obtained, and the pertinent conclusions reached in the engagement." AU §339.05. Further, "working papers ordinarily should include documentation showing that…(c) the audit evidence obtained, the auditing procedures applied, and the testing performed have provided sufficient competent evidential matter to afford a reasonable basis for an opinion, indicating observance of the third standard of field work." AU §339.05. Seidelman failed to document any conclusions reached regarding specific audit objectives supporting PwC's unqualified audit report. Seidelman also failed to document in the working papers any calculation or evaluation of quantitative materiality thresholds or any quantitative or qualitative materiality considerations for the 1999 audit. Because Seidelman failed to ensure documentation of the conclusions reached regarding specific audit objectives and any materiality determinations or considerations, the working papers did not adequately reflect that PwC obtained sufficient competent evidential matter affording a reasonable basis for its unqualified audit report.
17. GAAS' First Standard of Reporting stated, "The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles." AU §150.02. Contrary to this standard, Seidelman caused PwC to issue an unqualified audit report on Anicom's 1999 financial statements even though the financial statements did not conform to GAAP. Particularly, Seidelman knew, or should have known, that the $925,000 of the $6.1 million restructuring charge incurred by Anicom in the third quarter of 1999 did not meet GAAP requirements for one-time charges. Additionally, Seidelman knew, or should have known, that Anicom's recognition of revenue from approximately $1 million in unsubstantiated sales to an Anicom customer and from potentially misstated accounts receivable balances did not conform to GAAP requirements for revenue recognition.
18. GAAS' First Standard of Field Work required that "assistants...are to be properly supervised." AU §150.02. As the engagement partner, Seidelman was responsible for ensuring that the audit was properly supervised. Supervision included informing assistants of their "responsibilities and the objectives of the procedures that they are to perform" and of "matters that may affect the nature, extent, and timing of procedures…." AU §311.12. Seidelman failed to adequately inform the engagement team, or ensure that they were informed, of (a) Anicom's high-risk reevaluation and the reasons underlying the reevaluation; (b) the former Anicom employees' allegations of accounting fraud concerning accounts receivable; and (c) the red flags discussed in paragraph 14 above, so that they could properly perform the audit consistent with GAAS.
19. GAAS' First Standard of Field Work also required that assistants' work be reviewed to determine whether it was adequately performed and whether the results are consistent with the auditor's report. AU §311.13. Seidelman failed to adequately review the engagement team's work, or ensure that it was adequately reviewed, to determine that they obtained sufficient competent evidential matter in the areas of the audit identified in paragraph 16 above.
20. GAAS' Third General Standard provided, "Due professional care is to be exercised in the performance of the audit and the preparation of the report." AU §150. Among other things, due professional care required an auditor to observe the fieldwork and reporting standards of GAAS. AU §230.02. Additionally, due professional care required an auditor to employ professional skepticism, which is "an attitude that includes a questioning mind and a critical assessment of audit evidence." AU §230.07. GAAS also provided that an auditor, "neither assumes that management is dishonest nor assumes unquestioned honesty. In exercising professional skepticism, the auditor should not be satisfied with less than persuasive evidence because of a belief that management is honest." AU §230.09. For all of the reasons stated in paragraphs 13 through 19 above, Seidelman failed to exercise due professional care in violation of this standard.
21. In connection with an interim review, GAAS in effect at the time of Seidelman's first quarter 2000 interim review provided that "if, in the accountant's judgment, management does not respond appropriately to the accountant's communication within a reasonable period of time, the accountant should inform the audit committee, or others with equivalent authority and responsibility…of the matters as soon as practicable. If the information is communicated orally, the accountant should document the communication in appropriate memoranda or notations in the working papers." AU §722.21. Contrary to GAAS, Seidelman failed to document purported communications that he had with the chairman of the audit committee during the interim review regarding a material $9.5 million bill-and-hold sale that did not meet revenue recognition criteria when it was booked.
22. During the time of the conduct described above, Section 10A(b)(1) of the Exchange Act provided in relevant part:
"If, in the course of conducting an audit…, the independent public accountant detects or otherwise becomes aware of information indicating that an illegal act (whether or not perceived to have a material effect on the financial statements of the issuer) has or may have occurred, the accountant shall, in accordance with generally accepted accounting standards…determine whether it is likely that an illegal act has occurred; and if so, determine and consider the possible effect of the illegal act on the financial statements of the issuer…and as soon as practicable, inform the appropriate level of the management of the issuer and assure that the audit committee of the issuer, or the board of directors…in the absence of such a committee, is adequately informed with respect to illegal acts that have been detected or have otherwise come to the attention of such accountant in the course of the audit, unless the illegal act is clearly inconsequential."
23. Seidelman knew, or should have known, that Anicom improperly recognized revenue from a material $9.5 million bill-and-hold sale booked by Anicom at the end of the first quarter of 2000. Anicom's newly appointed vice-president brought this bill-and-hold sale to the engagement team's attention as an unusual transaction. Anicom's recognition of revenue from the transaction was improper under GAAP because it did not satisfy at least two revenue recognition requirements for a bill-and-hold sale. First, the bill-and-hold sale did not meet the "buyer request test," which requires that the buyer, not the seller, request that the sale be on a bill and hold basis. Second, the bill-and-hold sale did not meet GAAP requirements that there be a fixed schedule for delivery of product.
24. Despite numerous requests by Seidelman and the engagement team, Anicom never produced substantiating documentation to them that Anicom's customer, not Anicom, initiated the bill-and-hold. Additionally, Anicom never established that there was a fixed schedule of delivery for the product.
25. Because Anicom did not provide PwC with evidence supporting its recognition of revenue from the bill-and-hold sale, PwC had not determined the appropriate accounting for the bill-and-hold sale before Anicom filed the Form 10-Q. Consequently, PwC never completed its interim review of Anicom's first quarter 2000 financial statements. Anicom filed its Form 10-Q with the Commission without a completed interim review by PwC.
26. Seidelman continued to seek supporting evidence for the bill-and-hold sale after the commencement of the 2000 audit. However, Anicom still was unable to produce any evidence to Seidelman's satisfaction.
27. Notwithstanding Anicom's consistent failure to substantiate the accounting for the bill-and-hold sale, in addition to the red flags associated with the 1999 audit, Seidelman violated Section 10A(b)(1) of the Exchange Act when he failed to determine whether it was likely that Anicom's recognition of revenue from this bill-and-hold sale was an illegal act.
28. Seidelman also violated Section 10A(b)(1) of the Exchange Act when he failed to determine whether it was likely that Anicom's failure to obtain a completed interim review of its first quarter 2000 financial statements, as required by Rule 10-01(d) of Regulation S-X (17 C.F.R. §210.10-10(d)), was an illegal act.
29. Section 13(a) of the Exchange Act and Rules 13a-1 and 13a-13 thereunder require issuers with securities registered under Section 12 of the Exchange Act to file accurate annual and quarterly reports with the Commission. See SEC v. Savoy Industries, Inc., 587 F.2d 1149, 1165 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979). In addition, Exchange Act Rule 12b-20 requires that periodic reports contain all information necessary to ensure that statements made in such reports are not materially misleading. Anicom filed annual and quarterly reports with the Commission pursuant to Section 13(a) of the Exchange Act that contained materially false financial statements and failed to make required disclosures concerning its business practices. Anicom's books and records were inaccurate throughout the nine quarters from January 1998 through March 31, 2000. Thus, Anicom violated Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
30. Seidelman caused Anicom's violations of these reporting provisions for the five quarters from January 1, 1999 through March 31, 2000. He failed to determine that $925,000 of the $6.1 million restructuring charge incurred by Anicom in the third quarter of 1999 was inappropriate. He also failed to determine that Anicom should not recognize revenue from approximately $1 million in unsubstantiated sales to an Anicom customer and from potentially misstated accounts receivable balances. Although the accounting for these transactions did not conform with GAAP, Seidelman nevertheless prepared and approved PwC's unqualified audit report stating that Anicom's 1999 financial statements conformed with GAAP and that the audit was conducted in accordance with GAAS. Seidelman knew or should have known that these acts and omissions would contribute to Anicom's violations.
31. Based on the foregoing, the Commission finds that Seidelman engaged in improper professional conduct within the meaning of Rule 102(e)(1)(ii) of the Commission's Rules of Practice in connection with PwC's 1999 audit and first quarter 2000 interim review of Anicom's financial statements.
32. Based on the foregoing, the Commission finds that Seidelman violated Section 10A(b)(1) of the Exchange Act.
33. Based on the foregoing, the Commission finds that Seidelman caused Anicom's violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
In view of the foregoing, the Commission deems it appropriate to impose the sanctions agreed to in Seidelman's Offer.
Accordingly, it is hereby ORDERED, effective immediately, that:
A. Seidelman shall cease and desist from committing or causing any violations and any future violations of Section 10A of the Exchange Act and from causing any violations and any future violations of Section 13(a) of the Exchange Act and Rules 12b-20, 13a-1, and 13a-13 thereunder.
B. Seidelman is denied the privilege of appearing or practicing before the Commission as an accountant.
C. After 3 years from the date of this Order, Seidelman 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 Seidelman'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) Seidelman, 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) Seidelman, 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 Seidelman's or the firm's quality control system that would indicate that Seidelman 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) Seidelman 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) Seidelman acknowledges his responsibility, as long as he 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.
D. The Commission will consider an application by Seidelman 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 Seidelman's character, integrity, professional conduct, or qualifications to appear or practice before the Commission.
By the Commission.
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