by T. GormanPosted on Posted in SECActions

The Commission continues to initiate enforcement actions involving audit firms and their employees tied to violations of professional standards. Two recent actions involved an audit firm, its owner and the engagement quality review partner. One action centers on a failure of the firm and its owner to conduct proper audits and reviews. The other focuses on the failure of the Engagement Quality Review Partner to properly fulfill his obligations under the applicable PCAOB standards. In the Matter of DLL CPAS, LLC, Adm. Proc. File No. 3-19010 (March 1, 2019); In the Matter of Arthur Viola, Adm. Proc. File No. 3-19011 (March 1, 2019).

DLL is a public accounting firm that registered with the PCAOB on June 17, 2016. The firm subsequently conducted audits of the financial statements of five issuers whose shares are registered with the Commission along with reviews of quarterly reports for 2015 and 2016. The audits and reviews were conducted under the tutelage of Respondent Debra Lee Lindaman, a CPA and the person that formed the firm. Respondent Viola served as the Quality Review Partner on each engagement.

These proceedings center on the audits and reviews conducted for five issuers whose shares were at the time registered with the Commission and traded on OTC Link: CES Synergies, Inc., a firm based in Scottsdale, Arizona; Leo Motors, Inc., a firm based in Seoul, South Korea; American International, Ventures, Inc., a firm based in Lithia, Florida; and Omni Shrimp, Inc., a firm based in Rochester, New York.

The audits and reviews failed to comply with PCAOB standards in five key respects:

First, there was a failure to obtain audit documentation in accord with PCAOB Auditing Standard No. 1215 with regard to the engagements for Leo Motors, Kibush, CES and Omni Shrimp. Essentially, this standard requires that the workpapers contain sufficient information so that an experienced auditor with no connection to the engagement can review them and understand the work done, when it was completed and by whom. Here the work papers were so deficient that these determinations could not be made. For example, for the audits of Leo Motors’ financial statements the “vast majority of the balance sheet and income statement line items in the financial statements either completely lacked any associated workpapers . . . or there was not appropriate documentation included in the workpapers that existed such as the procedures performed, evidence obtained, or conclusions reached,” according to the Order.

Second, there was a failure to reconcile the financial statements and the underlying accounting records with respect to the engagements for CES, Leo Motors, Omni Shrimp and Kibush. For example, not only did the workpapers fail to reflect a reconciliation of the financial statements and the underlying accounting records, significant inconsistencies were not reconciled. Likewise, there is no evidence that the public filings for the firms were reviewed. None of the audit workpapers “contained a Form 10-K or a complete set of notes to the financial statements,” according to the Order.

Third, AS No. 1105 requires that the auditor plan and conduct audit procedures to obtain sufficient, competent evidential matter to provide a reasonable basis for the opinion stated. The workpapers here for CES and Leo Motors fail to comply with this requirement in certain respects. For example, the workpapers for CES’ accounts receivable, inventory, deferred tax asset, revenue, cost of sales, general and administrative expenses and going concern fail to meet this requirement.

Fourth, the procedures utilized to conduct the interim reviews were deficient. For quarterly reviews the procedures conducted are typically analytical such as comparing information for the current period and the one immediately proceeding the interim review. Here for the five issuers the reviews were often perfunctory and contained no meaningful analysis of variances in account balances from period to period. For some periods no workpapers were produced.

Fifth, AS No. 3101 regarding the report on audited financial statements requires that the auditor’s report contain an opinion on the financial statements taken as a whole and contain a clear indication of the character of the auditor’s work. The culmination of the deficiencies here rendered any claim that the work was done in accord with PCAOB standards false and misleading. Accordingly, the Order as to the firm and its owner alleges violations of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13 along with Regulation S-X Rule 2-02(b)(1).

To resolve the proceedings Respondents DLL and Ms. Linderman each consented to the entry of a cease and desist order based on these provisions. Each is also denied the privilege of appearing and practicing before the Commission as an accountant and will pay, on a joint and several basis, disgorgement of $25,000 along with prejudgment interest of $1,387.27.

Finally, Mr. Viola as the reviewing partner, was required to conduct Engagement Quality Reviews as to each of the five issuers. Here, it is clear that the required reviews were not conducted. The Order alleges violations of the same provisions cited in the one involving the company.

To resolve the proceedings Respondent Viola consented to the entry of a cease and desist order based on the Section and Rules cited in the Order. He is also denied the privilege of appearing and practicing before the Commission as an accountant. Respondent may request to be considered for reinstatement after five year. In addition, Mr. Viola will pay disgorgement of $4,800 and prejudgment interest of $228.48.

The five issuers involved here were previously audited by a firm that was censured and barred from being an associated person of a registered public accounting firm. The PCAOB also revoked the registration of the firm. Prior to the formation of DLL neither that firm nor Ms. Lindaman had audited a public company. The firm requested its registration be revoked.

Program: Women in Compliance, March 9, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.

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by T. GormanPosted on Posted in SECActions

The standards by which issuers or market professionals are governed are critical. Those standards guide the dealings of investment advisers, for example, entrusted by clients with their capital. It is for this reason that many of the Commission’s enforcement actions center on a breach or violation of the governing standards of the organization. Examples of those cases run the gamete from insider trading which is based on a breach of standards to those involving investment advisers who fail to properly disclose fees.

The Commission’s most recent action against a CFO dealing with questions regarding related party transactions or RPTs is based on this approach. There the CFO essentially did an end run around the firm’s well-established principles governing RPTs. In the Matter of Mark E. Kchenrither, Adm. Proc. File No. 3-19009 (March 1, 2019).

Mark Kuchenrither served as Executive Vice President and CFO of EZCORP, a firm with two classes of shares. The Class A shares are listed on NASDAQ but do not carry voting rights. The Class B shares do have voting rights. All of those shares are owned by the Controlling Shareholder.

The board of directors approved a Policy for Review and Evaluation of Related Party Transactions in September 2009. The firm’s General Counsel developed a process to implement the RPT Policy under the supervision of the audit committee which had been delegated authority to assess the fairness of related party transactions. The process was designed to ensure that transactions involving the company and the Controlling Shareholder were fair.

The Audit Committee retained an Advisor to furnish an opinion each year on whether the annual consulting agreement with the Controlling Shareholder was financially fair to EZCORP. That process in part hinged on a comparison of the proposed fee involved in the arrangement with the Controlling Shareholder with EZCORP’s projected revenue, earnings and other metrics for the coming year.

Over a four year period, beginning in 2009, the Advisor provided an opinion that the proposed consulting agreement was fair. The company then disclosed the agreement in a Form 8-K as a related party transaction.

In 2014 the Advisor informed the company that it would not approve the proposed Consulting Agreement because the consulting fee exceeded the acceptable fee-to-earnings ratio based on EZCORP’s financial projections. The Controlling Shareholder rejected a request to reconsider the fee.

The Audit Committee Chairman then asked Mr. Kuchenrither to reassess the financial position of the company since the Advisor’s determination hinged on the fact that the firm’s projected earnings were less than $240 million. The CFO revised the earnings projection over the next four days, increasing it from $187 million to $242.9 million. The increase was based on two assumptions: 1) that EZCOERP would complete a $300 million high-yield debt offering and 2) that the firm would use part of the proceeds to acquire several companies during the year. After reviewing the revisions, the Advisor approving the Consulting Agreement.

The CFO did not, however, have a reasonable basis for the two assumptions on which the new projections were based. The CFO essentially double counted the impact of the high-yield debt offering since it was included in the original financial projections. Reliance on the contemplated acquisitions was equally flawed. Indeed, the firm had conducted few discussions with its list of proposed targets. That fact was known, or should have known, to the CFO since he was a member of the acquisition committee. Nevertheless, EZCORP proceeded to disclose the new agreement filings with the Commission. The filing did not include any discussion regarding the Advisor’s initial opinion or the CFO’s revamping of the financial projections based on flawed assumptions. The Order alleges violations of Securities Act Sections 17(a)(3).

To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the section cited in the Order. He also agreed to pay a penalty of $50,000.

Program: Women in Compliance, March 19, 2019 at the offices of Dorsey & Whitney, LLC, New York New York. Details and registration are here.

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