Home -> Law Blog Directory -> Corporate & Securities Law Blogs -> Jim Hamilton's World of Securities Regulation

Corporate & Securities Law

: Jim Hamilton's World of Securities Regulation

SEC Censures Outside Auditor of NASDAQ Shell Company that Owned Mainland China Manufacturer

By Jim Hamilton

The SEC censured the outside auditor of a NASDAQ-listed shell company with ownership of a Mainland China manufacturer of energy savings products for failing to exercise professional skepticism and take due professional care with regard to revenue recognition and failing to consider the reasonableness and consistency of management?s response to inquiries concerning significant sales transactions. The SEC also suspended the engagement partner on the audit from Commission practice for at least two years and entered a cease and desist order against the audit firm and the engagement partner. The audit firm and its partner settled the proceeding without either admitting or denying the SEC?s findings.

As part of the settlement, the audit firm agreed not to accept any new issuer audit clients with operations located in the People's Republic of China, the Hong Kong Special Administrative Region, and Taiwan, between the date of the SEC order and the issuance of a certification that the firm has complied with the recommendations of an independent consultant that it has agreed to hire to ensure that its procedures will produce audits in compliance with SEC regulations and PCAOB standards and rules. In the Matter of Moore Stephens Wurth Frazer & Torbett LLP, AAER No. 3221.

Although the audit firm and its engagement partner determined that the audit engagement involved high risks, noted the SEC, they did not exercise professional skepticism and due professional care, and otherwise violated professional standards. The audit firm issued unqualified audit opinions, which were included in the company?s FY 2004 and 2005 annual reports.

During the engagement, the auditors learned information that contradicted disclosures in the company?s annual reports. The company claimed in its filings that the Mainland operations were located on a single floor of a building. But when the audit team arrived at that location to begin their audit field work, none of the industrial?s inventory was at the site.

The SEC found that the company materially overstated earnings per share (EPS) in its annual report for FY 2004. At the time, the company lacked accounting personnel trained in U.S. GAAP and was unable to complete a calculation. At the company?s request, the audit firm prepared the initial EPS calculation. In making the calculation, however, a firm accountant used the wrong number of shares, which had the effect of overstating EPS. The engagement partner reviewed the draft calculation but did not identify the error. The company adopted the calculation without change and included the overstated EPS in its annual report. The Commission also found that the engagement partner acquiesced in the company?s improper revenue recognition and accepted company that were inconsistent with the company?s prior representations and with contracts and other company records.

As part of the settlement, the audit firm agreed to hire an independent consultant to evaluate whether its policies and procedures are were adequate to ensure compliance with SEC regulations and PCAOB standards and rules. Within 60 days, the consultant must report to the SEC and Board with recommendations designed to ensure that the firm?s outside audits of a client company?s financial statements so conform. The audit firm agreed to implement the recommendations as soon as practicable unless it can negotiate an alternative with the consultant.

Within sixty days of issuance of the report, the audit firm must certify to the SEC and the PCAOB in writing that it has implemented or will implement all the consultant?s recommendations. Finally, six months after issuance of the certification the consultant will undertake a follow-up evaluation of the firm?s compliance with the matters certified. Within thirty days after the completion of this evaluation, the consultant will issue a supplemental written report to the SEC and PCAOB certifying the firm?s compliance, describing any matters on which it was unable to certify compliance, and making recommendations designed to ensure that the firm?s audits comply with SEC regulations and PCAOB standards and rules

Full post as published by Jim Hamilton's World of Securities Regulation on December 21, 2010 (boomark / email).