Three BDO Auditors Sanctioned by SEC For “Backdated Audit”

Accounting and auditing cases have long been a staple of SEC enforcement. While the PCAOB has had jurisdiction over matters relating to registered audit firms and their members, the Commission has continued to focus on proceedings involving these critical gatekeepers. The most recent case brought in this area by the agency is a good example of the importance of these cases – the engagement partner ordered that an unqualified audit opinion be issued despite the fact that the field work had not been completed and critical procedures had not been conducted. The audit work papers were filled in later. Essentially the audit work was “backdated.” In the Matter of Richard J. Bertuglia, CPA, Adm. Proc. File No. 3-18868 (October 12, 2018).

The proceeding center on the audit by BDO USA, LLP of the financial statements of AmTrust Financial Services, Inc., an underwriter of casualty insurance, to be included in the 2013 Form 10-K, filed in March 2014 with the Commission. Named as Respondents: are Richard J. Bertuglia, CPA, the engagement partner; John W. Green, CPA, the engagement quality review partner; and Lev Nagdimov, CPA, a senior audit manager.

BDO was engaged by AmTrust to conduct an integrated audit of the firm’s 2013 consolidated annual financial statements and ICFR in accord with PCAOB standards (“Consolidated Audit”). The audit firm was also engaged to audit many of the individual subsidiaries’ financial statements. Engagement partner Brtuglia supervised the work of the audit team. Portions of the work were delegated to Mr. Nagdimov.

In the fourth quarter of 2013 the engagement team was behind schedule. Specifically, in mid-December 2013 the team estimated that it was about 14 weeks behind. In the first week of January the SEC staff issued a subpoena to BDO, requesting copies of the firm’s work papers and audit files related to AmTrust.

Mr. Bertuglia focused on substantially completing the work on all major financial statement audit areas prior to the time AmTrust issued its earnings release on February 13, 2014. Accordingly, he directed the audit team to complete work on the consolidated audit of the firm but delay work on the subsidiaries. To implement this approach a manual review was conducted to identify accounts that exceeded the Consolidated Audit’s tolerable misstatement threshold and ensure that any untested balanced did not exceed consolidated materiality. This constituted a deviation from the audit plan.

Subsequently, on February 21 Engagement Partner Bertuglia met with the audit team. He instructed them to finish their incomplete audit work for journal entry and internal control testing as well as for material account balances for the Consolidated Audit before AmTrust filed its Form 10-K. Mr. Nagdimov then instructed the team to ensure that all their work papers and audit programs were loaded and singed in APT – the firm’s software which required work papers be loaded and recorded the signature dates but permitted later updating – regardless of whether the work was complete. Several days later the team was instructed to load everything, including signed blank papers to serve as placeholders if the work was not done. The instructions were implemented.

The audit team expected AmTrust to file its Form 10-K on Friday, February 28, 2014 Messrs. Bertuglia and Green reviewed the work papers in APT, noting that several were blank. Mr. Bertuglia stated that during a call he and Mr. Green were informed by Mr. Nagdimov that the audit team had completed its work but there were technical problems with loading the updated work papers. The review of the work papers continued. Messrs. Bertuglia and Green collectively signed off on over 2,000 work papers, including some which they did not review. The audit opinion was released on February 28, 2014. When AmTrust decided to delay issuing the report and filing the Form 10-K until March 3, 2014, the auditors continued reviewing the work papers and re-dated the audit report to March 3, 2014.

On March 7, 2018 the audit staff members emailed Messrs. Bertuglia and Nagdimove noting that the team needed more time to complete the Consolidated Audit of the firm. The audit team continued with its work, completing it over the next month. For the incomplete, predated work papers, including those that were placeholders, the team generally overwrote the documents thereby replacing the prior documentation with new papers reflecting the work done and evidence obtained. The new documentation did not indicate that the work had been done after the report was released. Mr. Bertuglia reviewed the completed work and concluded that the omitted procedures did not affect BDO’s previously issued audit report. Mr. Green also reviewed the work and reached the same conclusion. There were no work papers assessing the omitted procedures. Messrs. Bertuglia and Green did not document their own assessment or review.

The audit team did not, based on these facts, have sufficient audit evidence to support BDO’s audit opinion that was included in the AmTrust Form 10-K on March 3, 2014, according to the Order because:

· Journal entries: There was incomplete journal entry testing which had been identified as a fraud risk factor related to managements’ potential override of internal controls during the planning of the engagement.

· Control testing: There was incomplete control testing for premium underwriting, treasury and investments, entity-level controls and share-based compensation since the team failed to complete the necessary work in these areas prior to the second report release date.

· Substantive tests, material accounts: There was incomplete testing for material accounts identified in the audit plan concerning premium revenue, premium receivables, and share-based compensation.

· Other fraud risk areas: While the audit plan identified areas related to fraud risk, including vendor fraud, the engagement team failed to complete the work in these areas.

As a result Messrs. Bertuglia and Nagdimov violated PCAOB standards by failing to properly supervise and exercise due professional care. Mr. Bertuglia also failed to properly examine journal entries for evidence of possible material misstatement due to fraud or to perform sufficient tests of internal controls. Both accountants failed to appropriately respond to the risks of material misstatement by not completing certain audit procedures and to prepare and retain required audit documentation. Mr. Green failed to perform an appropriate engagement quality review.

To resolve the proceedings each Respondent consented to the entry of an order based on Rule 102(e)(1)(ii) denying them the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement after: as to Mr. Bertuglia, three years; as to Mr. Green, after one year; and as to Mr. Nagdimov, after five years.

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This Week In Securities Litigation (Week ending October 12, 2018)

Earlier this year Chairman Clayton in cautioning investors regarding the volatile nature of crypto assets, warned market participants about adding terms such as “blockchain” to the firm name to hype the price of the stock. Now, as the market has evolved, the company may not be named Blockchain something is — the Blockchain Exchange Commission. It is an SEC like agency protecting those who are active in the digital investment market place – at least according to the defendants in the SEC’s latest investment fraud action centered on an ICO. The BEC may be a good agency for the SEC’s Office of Investor Education to pare with its Howeycoins.

With the end of the Government fiscal year past, the race to the court house has ended for the Enforcement Division. Members must be tired from all that running while carrying complaints. This week the agency only filed two new cases, not the dozen or more that were being brought each week (or sometimes in a day) prior to the end of September.


Strategic plan: The Commission announced a new strategic plan for the next four years. It will focus on main street investors, recognize significant developments in the capital markets and adjust to effectively allocate available resources and elevate performance by enhancing analytical capabilities and human capital development (here).

Proposed rules: The agency is reopening the comment period for proposed rules and amendments for capital, margin and segregation requirements for security-based swap dealers and major security-based swap participants and capital requirements for broker-dealers (here).

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 2 civil injunctive cases and no administrative proceedings, excluding 12j and tag-along proceedings.

ICO offering: SEC v. Blockvest, LLC, Civil Action No. 18 cv 2287 (S.D. CA. Filed under seal Oct 3, 2018, unsealed Oct 11, 2018) is an action which names as defendants the firm, which purports to be involved with various digital asset related financial products and services, and Reginald Buddy Ringgold, III, a self-described Financial Markets Investment Coach and professor. Defendants claim to have raised about $2.5 million from investors in a pre-ICO offering and are now preparing to launch an ICO to raise about $100 million to fund Blockvets’s digital asset-related financial products and services. The space is safe for investors, according to Defendants, because the Blockchain Exchange Commission – a regulatory agency modeled after the SEC and created by Mr. Ringgold – is protecting digital investors. The ICO offering has been approved by the SEC and other regulators investors were told. Defendants ignored a cease and desist letter by the National Futures Association. In reality Defendants do not have any regulatory approvals. The complaint alleges violations of Securities Act sections 5(a), 5(c) and each subsection of 17(a) and Exchange Act section 10(b). The court entered a temporary freeze order. The case is in litigation. See Lit. Rel. No. 24314 (Oct. 11, 2018).

Trading: SEC v. Shapiro, Civil Action No. 15-cv-7045 (S.D.N.Y.) is a previously filed action which named as defendants Ross Shapiro, Michael Gramins and Tyler Peters, all RMBS traders at Nomura Securities International. Defendants were alleged to have defrauded counterparties in the opaque RMBS trading market by furnishing them false information regarding pricing. Mr. Shapiro settled with the Commission, consenting to the entry of a permanent injunction based on Exchange Act section 10(b) and Securities Act section 17(a). The Commission also entered and administrative order barring Mr. Shapiro from the securities business. See Lit. Rel. No. 24312 (Oct. 10, 2018).

Insider trading: SEC v. Hamilton, Civil Action No. 3:16-cv-00192 (D. Conn.) is a previously filed action which named as a defendant Dennis Hamilton, a former executive at Harman International Industries, Inc. Defendant traded on four occasions on inside information obtained from his employment in the shares of his firm. To resolve the matter Mr. Hamilton consented to the entry of a permanent injunction prohibiting future violations of Securities Act section 17(a) and Exchange Act section 10(b). In addition, the court imposed an officer/director bar and directed that he pay disgorgement of $730,279, prejudgment interest of $102,145 and a penalty of $584,047. The monetary judgment will be offset by the $131,958 Defendant was ordered to pay in the parallel criminal case. The Commission also entered an order in an administrative proceeding under Rule 102(e) suspending Mr. Hamilton from appearing or practicing before the agency as an accountant. See Lit. Rel. No. 24311 (Oct. 10, 2018).

Offering fraud: SEC v. Hitt, Civil Action No. 1:18-cv- 01262 (E.D. Va. Filed Oct. 5, 2018). Defendants in the action are local real estate developer Todd Hitt, along with his two firms, Kiddar Capital LLC and Kiddar Group Holdings, Inc. Mr. Hitt is the managing member of Kiddar AQ, a fund he advised as to the value of securities and investments in firms such as Aquicore, Inc. A number of Mr. Hitt’s related entities are named as relief defendants. In 2014 Mr. Hitt began raising capital for the Home Building Fund which provided liquidity to residential homebuilders in northern Virginia. The pooled investment fund extended loans to developers in exchange for a second mortgage on each property being developed. The loans carried an interest rate of 12% and, at sale, an additional fee of 3-5% was due — the Fund’s ROI. At least 15 investors were solicited to invest in the Home Building fund over the last several years. About $4.5 million was raised. The representations used to solicit the investors were false. Defendants misappropriated a significant portion of the money raised. In some instances they also misappropriated a portion of the ROI from a project. While Defendants solicited investors for other projects in 2017, Mr. Hitt’s signature deal was Herndon Station Property. The five story commercial building was located adjacent to the planned subway station for the Washington D.C. metro system in Herndon, Virginia. The plan was to acquire the property by borrowing $24 million from a bank using a $6 million contribution by the General Partner and raise an additional $6 million in a private offering to limited partners. Investors were told that Kiddar Capital was planning to contribute half of the equity required for the project. Select partners would then be permitted to acquire interests in the second half. In fact Defendants raised over $9 million for the deal – more than the half that was supposed to be raised from outside investors — and then continued to seek investor funds, including another $6 million from an offshore investment company. About $1.6 million of that investment was diverted to Mr. Hitt’s personal accounts and expenses. Defendants never put in their capital as represented. Overall Defendants raised at least $20 million from 29 investors for this project. The complaint alleges violations of each subsection of Securities Act section 17(a), Exchange Act section 10(b) and Advisers Act section 206(1) and 206(2). Defendant Hitt settled with the Commission, consenting to the entry of a conduct based injunction prohibiting him from participating in the offer or sale of interests in real estate development firms. He also agreed to the entry of a freeze order and the appointment of a receiver. See also U.S. v. Hitt, No. 1:15-cr-480 (E.D.Va.)(parallel criminal action).

Criminal cases

Offering fraud: U.S. v. Braziler, No. 17-cr-385 (E.D.N.Y.) is an action which names Yevgeniy Braziler as a defendant. Mr. Braziler pleaded guilty this week to one count of securities fraud. The charge and plea were based on a scheme he executed which raised over $1.8 million from investors whose funds were supposed to be invested in residential real estate that would be renovated and then rented or sold. Mr. Braziler misappropriated most of the investor money. The date for sentencing has not been set.

Offering fraud: U.S. v. Zamoras, No. 1:18-cr-00677 (N.D. Ill. Filed Oct. 10, 2018) is an action which names Lucita Zamoras as a defendant. Mr. Zamoras operated First Fidelity Financial Group LLC, specializing in retirement planning and targeting elderly individuals, particularly immigrants. He claimed that investor funds would be put into safe, low risk investments. In fact he diverted about $2.5 million of investor funds to his personal use. Defendant has been charged with one count of mail fraud. The case is pending

Offering fraud: U.S. v. Henning (S.D.N.Y. Oct. 9, 2018). Defendant Steven Henning is a certified public accountant who was the Managing Partner at a Manhattan accounting firm. He was also the Partner-in-Charge of Advisory Services and served on the firm’s Executive Committee. Prior to joining the firm Mr. Henning had been a Professor of accounting at a Texas university. He had also served as an Academic Fellow in the Office of the Chief Accountant at the U.S. Securities and Exchange Commission. In June 2008, while still with the accounting firm, Mr. Henning formed OpportunIP, LLC for which he was the CEO. He held an interest in the fund through a family partnership. Other members of the accounting firm owned interests.

In May 2012 Mr. Henning told one of his prior students from the University about the firm, describing it as a venture through which he would establish partnerships with owners or developers of intellectual property and assist them in taking that IP to market. Two years later Defendant Henning approached Former Student about investing in the firm. Specifically, he offered an opportunity to invest in a situation where an IP owner needed a $500,000 loan to get past certain financial difficulties. The loan would be repaid in six months. Over time Mr. Henning convinced Former Student and another to invest over $2 million. The investments were fraudulent – offers made with falsified documents. Mr. Henning was charged with wire fraud. The case is pending.

Offering fraud: U.S. v. Holdaway, No. 3:16-cr-00250 (N.D.CA.) is an action in which defendant Kevin Kyes was sentenced to serve five years in prison. Previously, a jury had found him guilty of one count of conspiracy to commit wire fraud, seventeen counts of wire fraud, one count of conspiracy to commit money laundering and two counts of money laundering. The convictions were based on a three year scheme that began in 2012. During the period Defendant Keys, along with John Holdaway, defrauded a group of Japanese investors out of about $6.8 million by convincing them to invest in a program called Money Management Strategies. MMS as it was known promised to invest in high speed trading and yield over 100% annually. Investor money was safe because it was only used a collateral for a bank loan that funded actual trades. In fact the scheme was a fraud and the money was misappropriated. In addition to the prison term Mr. Kyes was sentenced to serve three years of supervised release and pay over $3.6 million in restitution.

Hong Kong

Remarks: Thomas Atkinson, Executive Director, Enforcement, Securities and Futures Commission, delivered the keynote speech at the 2018 Refinitiv Pan Asian Regulatory Summit. The Director discussed the reorganization of the Enforcement Division into risk based teams and the work of the corporate fraud group and the intermediaries misconduct team along with what he called a non-traditional approach to enforcement.

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