The SEC filed its third action in recent weeks in which admissions of fact were required as part of the settlement process. In this instances the firm also admitted its conduct violated the federal securities laws. In the Matter of Grant Thornton, LLP, Adm. Proc. File No. 3-16976 (December 2, 2015); see also In the Matter of Melissa K. Koeppel, CPA, Adm. Proc. File No. 3-16977 (December 2, 2015).
Respondents in the two proceedings are the audit firm and two of its engagement partners, Ms. Koeppel and Jeffrey Robinson. Only the audit firm was required to make admissions in connection with the settlement.
The proceedings are based on two prior Commission enforcement actions. One involved Assisted Living Concepts, Inc., a publicly traded senior living company while the other centers on Broadwind Energy, Inc., an alternative energy company. In the Matter of Laurie Bebo and John Buono, Adm. Proc. File No. 3-16293 (December 3, 2014)(Ms. Bebo, who sought an injunction against the SEC was found liable in an Initial Decision by an ALJ while Respondent John Buono settled); SEC v. Broadwind Energy Inc., Case No. 15-cv-1142 (N.D. Ill.)(the company and two officers settled). Ms. Koeppel was the engagement partner on the firm’s audits of Assisted Living from 2007 through the second quarter of 2010. She was also the engagement partner on the Broadwind engagements from 2007 through the second quarter of 2010. Mr. Robinson was the engagement partner on the Assisted Living engagements from 2011 through the first quarter of 2013 when the firm terminated its relationship with Grant Thornton.
The Assisted Living action centered on the acquisition of 200 senior living residences from Ventas, Inc., a publicly traded real estate investment trust, and a related lease. Simultaneous with the acquisition Assisted Living entered into a lease to operate those facilities. That lease required in part that Assisted Living demonstrate compliance on a quarterly basis with certain financial covenants and provide detailed financial data prepared in accordance with GAAP. There were also certain occupancy requirements. Violation of the covenants could result in default.
Shortly after the transaction closed, occupancy began to decline. In an effort to avoid default on the lease covenants, Ms. Bebo devised a plan to include Assisted Living employees who stayed overnight at the leased facilities as occupants of the properties for purposes of complying with the lease provisions. Nevertheless, by the first quarter of 2009 Assisted Living was on the verge of default. Ms. Bebo directed CFO Buono and his staff to include employees and other non-residents in the financial covenant calculations. To effectuate this directive the accounting staff reverse engineered the numbers, determining the amount by which the firm would not meet the covenants and then prepare the necessary records to demonstrate compliance.
Using this approach, beginning in the first quarter of 2009, the firm furnished lessor Ventas the necessary financial data. Those materials demonstrated compliance by Assisted Living with the lease covenants. In 2011 the two officers represented to the auditors that they had no knowledge of any fraud or suspected fraud and that Ventas agreed with the manner in which the occupancy requirements were being met.
The scheme unraveled over a 2012 lawsuit filed by Ventas which was unrelated to the lease covenants. In connection with attempting to settle that suit, the Assisted Living board insisted that a release be secured from Ventas regarding the practice of including employees in the calculations for compliance with the covenants. When this was disclosed to Ventas, the firm amended its complaint to include a claim based on the practice. Ventas also issued a notice of default in which it accused Assisted Living of fraud based on the employee adjustment. In addition, an Assisted Living employee filed a whistleblower complaint with the audit committee disclosing the practices.
Eventually the suit was settled. Assisted Living paid about $100 million to settle the suit and acquire the operations. Since an appraisal demonstrated that the facilities were only worth about $62.8 million, the financial statements for the second quarter of 2012 contained an expense of $37.2 million described as “lease termination and settlement.” The remaining lease intangible assets associated with the Ventas facilities were written off at a total of about $8.96 million.
The impact of the scheme was reflected in the Forms 10-K for the years ending December 31, 2009, 2010 and 2011. In each year the audit firm failed to identify the fraud despite a number of warning signs. As a result of the failed audits for each year investors were falsely told that Assisted Living was in compliance with the leave covenants.
Broadwind centered the failure to take impairment charges. While typically intangible assets such as customer relationships cannot be recognized, there is an exception for business combinations. One established however, the asset is subject to periodic impairment reviews.
Here the firm booked $76 million as amortizable intangible assets and $26 million as good will in connection with an acquisition in 2007. Most of the $76 million related to two significant customers. The value was established by an appraisal firm.
Beginning in 2008 the two customers substantially reduced actual and forecasted orders. This caused declines in actual and projected revenue associated with the relationships. Internal projections reflected the declines. By the fourth quarter of 2009 the declining relationships triggered event tests established by FAS 144 and the assets were impaired. As a result Broadwind materially overstated its intangible assets and understated a material impairment charge in its Form 10-Q for the third quarter of the year.
The firm sought to raise capital in view of these events through a stock offering. In early 2010 the company filed a registration statement with the Commission that incorporated the third-quarter Form 10-Q which included the financial statements that failed to record the impairment charge. Less than two weeks later one of its appraisal firms reported to management a preliminary finding of impairment. One month later the firm disclosed in its 2009 Form 10-K a $58 million impairment charge, $56 million of which related to the decline tied to the two customers. Broadwind’s operating loss increased from $28 million to $110 million on reported revenues of $198 million.
Grant Thornton’s failure to exercise due professional care contributed to Broadwind improperly omitting from its financial statements that it had sustained a $58 million impairment charge. That failure also contributed to the firm’s conducting a public offering in which the impairment charge was concealed.
The Order as to the firm alleged violations of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13. To resolve the action the firm admitted to the facts in the Order and that it violated the federal securities laws. The firm also agreed to a series of undertakings, including conducting a complete review and evaluation of certain quality controls and policies and procedures for audits and interim reviews. It consented to the entry of a cease and desist order based on the Sections and Rules cited in the Order as well as a censure. The firm will also pay disgorgement of $1,305,396, prejudgment interest and a penalty of $3 million.
The Order as to Ms. Koeppel alleged violations of Exchange Act Section 13(a) and Rules 13a-1 and 13a-13. The Order as to Mr. Robinson alleged violations of the same Section but only Rule 13a-1.
To resolve the proceeding each engagement partner consented to the entry of a cease and desist order based on the Section and Rule or Rules cited in the Order as to them. Ms. Koeppel is also denied the privilege of appearing and practicing before the Commission as an accountant with the right to apply for reinstatement after five year. She will pay a penalty of $10,000. Mr. Robinson is denied the right to appear and practice before the Commission as an accountant with the right to apply for reinstatement after two years. He will pay a penalty of $2,500.